UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-K
Commission file number 001-07260
NORTEL NETWORKS CORPORATION(Exact name of registrant as specified in its charter)
Registrant’s telephone number including area code: (905) 863-0000
Securities registered pursuant to Section 12(b) of the Act:
The common shares are also listed on The Toronto Stock Exchange in Canada
Securities registered pursuant to Section 12(g) of the Act: None
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 No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
At February 28, 2002, 3,204,652,807 common shares of Nortel Networks Corporation were issued and outstanding. Non-affiliates of the registrant held 3,189,916,346 common shares having an aggregate market value of $16,172,875,874.22 based upon the last sale price on the New York Stock Exchange on February 28, 2002, of $5.07 per share; for purposes of this calculation, shares held by directors and executive officers have been excluded.
Listed hereunder is the document to be incorporated by reference and the Parts of the Form 10-K into which the document will be incorporated:
TABLE OF CONTENTS
i
ii
All dollar amounts in this document are in United States dollars unless otherwise stated.
BAYSTACK, CONTIVITY, DMS, DMS-HLR, DMS-MSC, DMS-MTX, EPICON, MERIDIAN, MERIDIAN 1, NORSTAR, NORTEL NETWORKS, OPTERA, OPTIVITY, PASSPORT, PERIPHONICS, PRESIDE, S/DMS TRANSPORTNODE, SHASTA, SUCCESSION, and SYMPOSIUM are trademarks of Nortel Networks.
ALTEON is a trademark of Alteon WebSystems.
ACCESSNODE and UNIVERSAL EDGE are trademarks of Zhone Technologies, Inc.
CLARIFY is a trademark of Amdocs Software Systems Limited.
JUNGLEMUX is a trademark of GE Industrial Systems Technology Management Inc.
iii
PART I
ITEM 1. BUSINESS
Overview
Nortel Networks Corporation is a leading global supplier of products and services that support the Internet and other public and private data, voice, and multimedia communications networks using terrestrial and wireless technologies which we refer to as “networking solutions.” Our networking solutions generally bring together diverse networking products from our various product families, and related services, to create either a customized or “off the shelf” solution for our customers. Our business consists of the design, development, manufacture, assembly, marketing, sale, licensing, financing, installation, servicing, and support of networking solutions. Our networking solutions include network equipment, software, and other technologies that enable local and long-distance telephone companies, Internet service providers, and other communications service providers to provide their customers with the ability to communicate locally or globally, through the use of data, voice, and multimedia communications. Our networking solutions also provide enterprises, such as large and small businesses, governments, and other organizations, with the ability to communicate locally or globally within their organization and with other individuals and organizations through the use of data, voice, and multimedia communications. With our networking solutions, we are focused on providing the infrastructure and applications for high-performance networks, as technology transforms the way we communicate and conduct business.
In the fourth quarter of 2001, we reorganized our operations and evolved the way we manage our business to focus on providing seamless networking products and service capabilities across three core business areas. We now conduct business in three operating segments: Metro and Enterprise Networks, Wireless Networks, and Optical Long-Haul Networks. Accordingly, our financial information by operating segment and product category have been modified and reported on a new basis commencing with the year ended December 31, 2001. We refer you to the descriptions of our “Metro and Enterprise Networks Segment,” our “Wireless Networks Segment,” and our “Optical Long-Haul Networks Segment” below. For financial information by operating segment and product category, we refer you to note 17 to the Consolidated Financial Statements, and to “Results of operations – continuing operations – Revenues – Segment revenues” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Company’s principal executive offices are located at 8200 Dixie Road, Suite 100, Brampton, Ontario, Canada, L6T 5P6; telephone number (905) 863-0000. The Company was incorporated in Canada on March 7, 2000 under the name New Nortel Inc. On May 1, 2000, the Company participated in a Canadian court-approved plan of arrangement with Nortel Networks Limited, previously known as Nortel Networks Corporation, and BCE Inc., the largest shareholder of Nortel Networks Limited prior to the plan of arrangement. In connection with the plan of arrangement on May 1, 2000:
The Company also assumed Nortel Networks Limited’s financial reporting history as of May 1, 2000, the date of the plan of arrangement, for financial reporting purposes. As a result, management deems Nortel Networks Limited’s consolidated business activities prior to May 1, 2000 to represent the Company’s consolidated business activities as if the Company and Nortel Networks Limited had historically been the same entity. References to “the Company” mean Nortel Networks Corporation without its subsidiaries. References to “we,” “our,” “us,” or “Nortel Networks” mean the Company and its subsidiaries.
1
Developments in 2001
In 2001, the telecommunications industry underwent a period of significant adjustment. During 2001, industry demand for networking equipment slowed significantly in response to the rapid and severe industry and economic downturn in the United States, Europe, and other parts of the world and the related decline in the global capital markets. As a result of this adjustment and the difficulties in obtaining financing for capital expenditures, the business marketplace in the telecommunications industry has changed. Significant excess network capacity now exists as a result of the pace of new network construction during 1999 and 2000 and also due to the financial difficulties now being experienced by a number of communications service providers around the world. Service provider customers are no longer investing in new networks or equipment based primarily on potential future demand. Customers, now focused on reducing their costs and exhausting existing network capacity, have returned to more conservative capital spending strategies and generally require current demand for network capacity prior to investing in new network expansions and equipment. This resulted in a significant reduction in 2001 in the levels of capital spending by communications service providers around the world.
In light of the significant downturn in both the telecommunications industry and the economic environment, and capital market trends impacting our operations and expected future growth rates, we engaged in a number of activities in 2001 to streamline operations and activities around our core markets and leadership strategies. Some of our activities in 2001 include:
The primary focus of these activities in 2001 was to reposition Nortel Networks from a financial perspective. As a result of these initiatives, we have substantially reduced our fixed costs and have created a business organization that we believe is better aligned to the new industry and economic environment. For information on these and other developments in 2001, see “Developments in 2001” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, and notes 4, 7, and 8 to the Consolidated Financial Statements.
Networking Solutions
Our networking solutions include network equipment, software, and other technologies that enable communications locally or globally through the use of data, voice, and multimedia networking. In our industry, networking refers to:
A telecommunications network generally consists of network access equipment, network transport equipment, and core networking equipment.
Network access – Network access refers to the portion of a network that runs from an end user to the network access equipment that resides in locations between the end user’s site and the interior, or “core,” areas of a network. We do not offer network access solutions for wireline networks, also known as terrestrial networks, or for fixed wireless networks. For
2
our network access solutions for mobile communications networks, we refer you to our “Wireless Networks Segment” description below.
Network transport – Network transport refers to the portion of a network that runs from network access equipment to core networking equipment, or from core networking equipment in one location to core networking equipment in another location. Network transport may be over wireline cabling (copper wire, fiber optic, or coaxial), or over wireless radio signals transmitted through the air between locations using antennas. Network transport by wireless radio signals is also known as digital radio transport. We do not offer digital radio transport products. The most common method for long-distance network transport is optical networking, which uses light particles/waves to transmit communications signals through fiber optic cables. For our long-distance optical transport products, we refer you to our “Optical Long-Haul Networks Segment” description below. For our other optical transport products, we refer you to our “Metro and Enterprise Networks Segment” description below.
Core networking – Core networking refers to the apparatus and workings of the interior areas of a network. Core networking equipment directs, routes, or “switches” the data, voice, and multimedia communications signals from one part of the network to another. For our general core networking products, we refer you to our “Metro and Enterprise Networks Segment” description below. For our specialized core networking products designed for wireless communications networks, we refer you to our “Wireless Networks Segment” description below.
Metro and Enterprise Networks Segment
Products
Our Metro and Enterprise Networks portfolio of wireline products provide data, voice, and multimedia communications for our customers. Our service provider customers include local and long-distance telephone companies, Internet service providers, and other communications service providers. Our enterprise customers include large businesses and their branch offices, small businesses, and home offices, as well as government, education, and utility organizations. We refer you to “Metro and Enterprise Networks Segment – Customers” below. We offer our Metro and Enterprise Networks customers a range of Optical Ethernet solutions, packet switching and routing solutions, and circuit to packet network solutions. We also provide our customers with related professional services, including: strategic planning and network design services; operations planning and consulting services; technology and process outsourcing services; network applications and network content services; and installation and ongoing technical support.
Optical Ethernet
We offer our Metro and Enterprise Networks customers a broad range of solutions for metropolitan optical, or “Optical Ethernet,” networks. Optical Ethernet networks transport data, voice, and multimedia communications between locations within a city or between cities of close range by transmitting communications signals in the form of light particles/waves through fiber optic cables. Our customers use optical networking solutions to deliver customized services that include high-speed Internet access, network connections between offices within a city and between cities of close range, and support for the transport and storage of large amounts of data. We offer a suite of Optical Ethernet solutions designed to reduce the congested and complex metropolitan networking bottleneck created by the wide range of users and services that exist within cities (such as businesses, banks, schools, and home users all using the Internet and phone lines). Our Optical Ethernet networking products support data, voice, video, Ethernet, and other types of protocols (such as those used for data backup and storage), and are designed to be expandable, contractible, and generally flexible in order to support the dynamic communications traffic patterns that exist within cities. Our Optical Ethernet product portfolio for metropolitan optical networks consists primarily of the OPTera Metro 3000 series, the OPTera Metro 4000 series, and the OPTera Metro 5000 series.
Packet Switching and Routing
We offer a broad range of packet switching and routing solutions for our customers. Packet networking involves the partitioning of a data, voice, or multimedia communications signal into pieces, or “packets,” that are directed or routed through the network independently and then re-assembled at the destination, enabling large numbers of communications
3
signals to be directed or routed simultaneously and more efficiently than in circuit networking, which requires a separate network circuit to be maintained for each communications signal for the duration of the call. Our packet switching and routing systems include data switching systems, aggregation products, virtual private network gateways, and routers.
Circuit to Packet Voice Networks
Circuit switching systems enable communications signals to be selectively directed or “switched” from one network circuit to another. Our circuit to packet voice network solutions include our combined voice and data communications systems, our Meridian and Norstar enterprise telephone systems, our digital switching systems, our business solutions and applications, and our network management software. Our business solutions and applications include call centers, interactive voice response systems, web-response centers, and advanced speech recognition systems, all of which are designed to enable organizations to integrate customers into their electronic business processes.
4
5
Product Development
We are currently focused on developing products that support the continuing evolution of voice and data communications systems toward converged or combined voice and data networks.
Markets
We offer our Metro and Enterprise Networks products to service providers and enterprises around the world. With the growth of voice and data communications over the public telephone network, the public Internet, and private voice and data communications networks, there is an increasing opportunity to converge disparate networks towards a single, high performance network that can support most types of communications traffic and applications. This convergence of voice and data communications, and public and private communications, began with the common use of local and long-distance fiber optic communications networks to transport local and long-distance, public and private, and business and residential voice and data communications. Voice and data communications systems generally continued to use circuit-based technologies for voice communications, and more cost-effective packet-based technologies for data communications. As data, voice, and multimedia communications technologies continue to converge, we anticipate that in the future all communications networks will be able to carry data, voice, and multimedia communications effectively, and we anticipate that these networks will use packet-based technologies.
Historically, voice communications and data communications have operated on separate networks. Voice communications infrastructures transitioned from analog circuit switching systems to digital circuit switching systems during the 1980s and early 1990s. The demand for digital circuit-based voice communications equipment is now mature. During the mid to late 1990s, demand for data communications infrastructure equipment grew substantially, driven by the growth in data communications and the growth of the Internet. Although consumer use of existing voice communications infrastructures continues to grow, the per-minute rates that local and long-distance telephone companies can charge for these services have been declining due to competitive market forces. To meet the growing demand for increased capacity at lower per-minute rates, we anticipate that over the next five to 10 years service providers will transition their digital circuit-based voice communications infrastructures to more cost effective packet-based infrastructure technologies with the ability to carry data, voice, and multimedia communications. As a result, we anticipate growth over the same period in demand for packet networking equipment that supports the convergence of data, voice, and multimedia communications over a single communications network and that provides greater network capacity, reliability, speed, quality, and performance.
The market for our Metro and Enterprise Networks products is a global one, covering the United States and Canada, the Caribbean and Latin America region, the Europe, Middle East and Africa region, and the Asia Pacific region. Network security and resiliency has become a significant focus for enterprise customers worldwide, particularly in the aftermath of the September 11th terrorist attacks on the United States. In the United States and Canada, although most service providers are focused on reducing their capital spending in response to the industry and economic slowdown, many service providers continue to modernize their networks in response to the convergence of voice and data communications networks. Enterprise customers in the United States and Canada continue to invest in equipment for their communications networks, primarily for network security and resiliency, for voice communications over the Internet, and for virtual private networks. In the
6
Caribbean and Latin America region, enterprises are continuing to drive demand for networking equipment that supports the growing use of the Internet in the region. In the Europe, Middle East, and Africa region, we continue to see market demand for certain networking products, including metropolitan optical networking products, equipment for voice communications over the Internet, and equipment for virtual private networking. Service providers in Europe are also focused on reducing their capital spending, and we anticipate that a higher proportion of network infrastructure capital spending in Europe in 2002 will come from the leading national public telephone companies, as opposed to alternative service providers. In the Asia Pacific region, demand for networking equipment has slowed, but is continuing, largely due to the significant deployments of wireless communications services and the growing use of the Internet. In addition, enterprise customers in the Asia Pacific region are continuing to invest in networking equipment to improve the connections among their regional sites and branch offices.
Customers
We offer our Metro and Enterprise products and services to a wide range of service providers and enterprises around the world. Our service provider customers include:
We also offer our products and services to a broad range of enterprise customers around the world, including large businesses and their branch offices, small businesses, and home offices, as well as government, education, and utility organizations. Key industry sectors for our business customers include the telecommunications, high-technology manufacturing, and financial services sectors. We also serve business customers in the healthcare, retail, hospitality, services, transportation, and other industry sectors. We are currently focused on increasing our market presence with key global service provider and enterprise customers. In particular, we intend to focus on certain large service providers who we currently expect to account for a substantial proportion of service provider capital spending in 2002 and beyond, and leading enterprise customers with high performance networking needs. None of our Metro and Enterprise Networks customers represented more than 10 percent of Nortel Networks consolidated revenues in 2001.
Competition
Our principal competitors in the sale of our Metro and Enterprise Networks products to service providers are large communications companies, such as Alcatel S.A., Fujitsu Limited, Telefonaktiebolaget LM Ericsson, Lucent Technologies Inc., and Siemens Aktiengesellschaft. In addition, we compete with smaller companies that address specific niches within this market, such as Ciena Corporation and ONI Systems Corp. (who recently announced their intention to combine their companies) in metropolitan optical networking solutions, Sonus Systems Limited in Internet-based voice communications solutions, and Redback Networks Inc. in aggregation products. Certain competitors also are strong on a regional basis, such as Nippon Denki Kabushiki Kaisha (also known as NEC) and Huawei Technologies Co., Ltd. in Asia. No one competitor is dominant in this market. We expect competition to increase in intensity given the significant decline in 2001 in market demand, the substantially reduced availability of capital, the continued consolidation in the service provider industry, and the renewed focus by suppliers on selling to the remaining large service providers with financial resources.
Our principal competitors in the sale of our Metro and Enterprise Networks solutions to enterprises are Alcatel, Avaya Inc., Cisco Systems, Inc., Ericsson and Siemens. Cisco Systems is our most significant competitor in the sale of networking equipment to enterprises. We also compete with smaller companies that address specific niches, such as Foundry
7
Networks, Inc., Extreme Networks, Inc., and Enterasys Networks, Inc. in Ethernet switching, 3Com Corporation in Internet-based voice communications solutions, and Genesys Telecommunications Laboratories, Inc. in call centers. We expect competition to remain intense as corporate information technology spending continues to be affected by global and regional economies and the state of the global capital markets.
The principal global factors of competition in the sale of our Metro and Enterprise Networks products include:
The principal competitive factors for the sale of our products to service providers also include the leveraging of existing customer-supplier relationships, and the provision of customer financing. The principal competitive factors for the sale of our products to enterprises also include distribution channels.
Wireless Networks Segment
Wireless networking, also known as mobility networking, refers to communications networks that enable end users to be mobile while they send and receive voice and data communications using a wireless device, such as a cellular telephone. These networks use specialized network access equipment and specialized core networking equipment that enable an end user to be connected and identified despite the lack of a fixed location. The technology for wireless communications networks has evolved, and continues to evolve, through various technology “generations.” First generation (1G) wireless technology refers to analog wireless communications networks based on circuit switching technology that are limited to voice communications; second generation (2G) wireless technology refers to digital wireless networks based on circuit switching technology with very limited data transmission capabilities; and third generation (3G) wireless technology refers to digital wireless communications networks based on packet networking technology with voice, high-speed data, and multimedia transmission capabilities. Our existing wireless network solutions span all generations and most major global digital standards for mobile networks. The majority of wireless networks existing today are based on 2G wireless technologies.
There are several international standards for wireless communications networks. The main standards used today are Time Division Multiple Access (TDMA) supported mainly in North and South America, Code Division Multiple Access (CDMA) supported in both the Americas and Asia Pacific, and Global System for Mobile communications (GSM) supported all over the world. Universal Mobile Telecommunications System (UMTS) is the emerging standard for 3G networks with a European focus. TDMA is a 2G wireless standard that uses timeslots within a radio frequency channel to separate users’ conversations. CDMA is a 2G wireless standard that uses codes, much like encryption, to distinguish one call from another, with all calls in a given cell transmitted over the entire range of radio frequencies assigned to the network operator within the cell. CDMA networks are evolving to 3G according to the CDMA 3G (1xRTT) standard, also known as cdma2000, for voice and high-speed data mobility. 1xEV and 1xDV are also emerging CDMA 3G standards for high speed wireless networks for data, voice, and multimedia communications. GSM is a 2G wireless standard that, like TDMA, uses time slots within a specified radio frequency channel to distinguish one call from another. GSM networks are evolving to carry data, as well as voice, with the introduction of General Packet Radio Standard (GPRS). GPRS is viewed as a “2.5G” technology that provides an intermediate step between 2G and 3G wireless networks. UMTS is a 3G wireless standard that combines CDMA-based radio access with advanced switching techniques to yield high capacity, high speed wireless networks for data, voice, and multimedia communications.
We offer a broad portfolio of solutions for wireless communications networks. Our wireless networking products support the TDMA, CDMA, GSM, GPRS, and UMTS standards. We also offer a range of related professional services to
8
our customers, including: business planning services; network design services; site acquisition and installation services; network optimization services; and technical operations and maintenance services.
Radio network access equipment uses radio waves to provide wireless access to the subscriber’s handset, enabling the wireless subscriber to connect to the network to send and receive data, voice, and multimedia communications. The key network elements in radio access are (i) base station transceivers, and (ii) base station controllers. As a mobile subscriber moves away from the area covered by a base station transceiver, also known as a cell site, the subscriber will lose the call unless an adjacent cell site provides the coverage. This requires that an active wireless call be transferred from one cell to another cell without breaking or disconnecting the call in progress, also known as a “hand-off.” Base station transceivers and base station controllers work together with core network equipment to perform a call hand-off. We offer our customers a wide range of base station transceivers and base station controllers for TDMA, CDMA, GSM, GPRS, and UMTS standards, supporting a wide variety of network requirements, including metropolitan and dense urban networks, which are generally available in micro, macro, and mini base station transceiver packages. We do not manufacture or sell cellular phones.
Core networking equipment directs, routes, or “switches” communications signals within a service providers’ wireless communications network. The primary functions of core networking equipment in wireless communications networks are: identifying and authenticating the called party; locating the called party; directing the call through the system; and generating call detail records for billing purposes. The key network elements in the core part of a wireless communications network are: (i) mobile switching centers, and (ii) home location registers. Mobile switching centers direct or “switch” data, voice, and multimedia communications signals from one network circuit to another. A home location register is a database that contains permanent subscriber data, such as provisioning and service information, and dynamic information, such as the wireless handset’s current location. We offer mobile switching centers and home location registers that support TDMA, CDMA, and GSM core networks. Our Serving GPRS Support Node, which connects the GPRS “backbone” network to the base station transceiver and the home location register, registers and tracks mobile users and delivers data communications to cellular phones and other mobile devices in a given service area. Our GPRS Gateway Support Node routes data communications and connects the GPRS backbone network to external data networks. Our UMTS 3G core networking equipment, including our UMTS Serving Support Node and our UMTS Gateway Support Node, are currently in customer trials.
Our wireless networking products in development include our UMTS 3G products, the next evolution of our CDMA 3G products, and our GSM/EDGE (Enhanced Data rates for GSM Evolution) products.
9
In addition, our Adaptive MultiRate technology, which is designed to reduce the cost of existing GSM network ownership for wireless service providers by increasing capacity and radio spectrum efficiency of existing GSM base station transceivers without adding new equipment, is currently expected to be in customer trials in the second half of 2002. We also currently anticipate that the enhanced version of our GSM base station controller, the GSM BSC e3, will be commercially available in the first half of 2002.
The original wireless communications networks were built using 1G analog technology. In the early 1990s, advanced 2G digital technology based systems, including TDMA, CDMA, and GSM, were introduced. Over the next couple of years, we expect most of the remaining analog wireless networks to migrate to digital technologies. Since the beginning of 2000, many wireless service providers have been upgrading their GSM and TDMA (2G) wireless networks to a higher speed technology called GPRS (2.5G). In the next few years, we anticipate that new network construction and network upgrades will focus on the evolution to UMTS 3G systems, the evolution path for GSM and GPRS networks, and to CDMA 3G (1xRTT) systems, the evolution path for CDMA networks. Wireless service providers operating TDMA networks are expected to choose either UMTS 3G or CDMA 3G (1xRTT) systems based on their business strategies.
The global market for wireless networking equipment increased substantially from 1995 to 2000. However, in 2001, although our Wireless Networks revenues grew, growth in the global wireless networking market remained essentially flat. We believe that this was largely due to the weakening of global economic conditions and capital markets, and the decision of many wireless service providers to delay certain capital expenditures, given the high costs of 3G licences, particularly in Europe, and the significant decline in available financing. TDMA is a mature technology, and demand for TDMA networking equipment declined in 2001. Demand for GSM networking equipment is expected to decline over the next few years, even though GSM-based systems continue to represent more than half of the global market for wireless networking products. Demand for CDMA 2G (IS-95) technology is also expected to decline over the next few years. Our customers are wireless service providers, and their customers are the subscribers of wireless communications services. In 2001, we believe that global economic uncertainties, as well as high penetration rates in Europe, contributed to slower wireless subscriber growth. In addition, we expect that wireless subscriber growth rates for 2G technologies, including TDMA, CDMA 2G (IS-95), and GSM, to continue to slow in the future, given existing subscriber penetration rates and user migration to the newer 2.5G technologies (GPRS) and 3G technologies (CDMA 3G (1xRTT), and UMTS).
There are two key aspects to the migration from 2G wireless communications technologies to 2.5G and 3.G wireless communications technologies. The first is that all current 3G technologies, including UMTS and CDMA (1xRTT), are based on code division (CDMA) technology. The second is that the migration from 2G to 2.5G and 3G technologies is largely based on a transition from circuit switching technologies in 2G core networks to packet networking technologies in 3G core networks. We believe that our extensive experience in deploying CDMA 2G (IS-95) wireless communications networks, combined with our expertise in packet networking for wireline networks, will be a competitive strength for our business during the expected market transition from 2G wireless communications networks to 2.5G and 3G wireless communications networks. However, the timing of changes in revenues in the short term from the different wireless technologies has become increasingly difficult to predict as a result of the continuing industry and capital markets adjustment and the complexities and potential for delays in implementation of 3G network deployments.
Over the next two to three years, we anticipate that demand for wireless networking equipment will be driven primarily by the growth of 2.5G and 3G wireless networking systems. GPRS networks have already been launched in Europe, while some North American wireless service providers are currently building their GPRS networks. Some Korean wireless service providers have already commercially launched CDMA 3G (1xRTT) networks. UMTS network deployment has been delayed, generally due to economic uncertainties, capital market constraints, delays in UMTS cellular phone availability, and the high license fees that must be paid by UMTS wireless service providers. However, we currently expect a number of European UMTS networks to be launched by the end of the second half of 2002, with mass-market take-up beginning in 2003.
10
The market for our Wireless Networks products is a global one, covering the United States and Canada, the Caribbean and Latin America region, the Europe, Middle East and Africa region, and the Asia Pacific region. In the United States and Canada, usage rates of wireless communications services continue to increase, and we anticipate that capital spending decisions by wireless service providers will be driven by capacity requirements, new wireless subscribers, increased use of wireless devices for Internet access, and technology migration from 2G wireless technologies to 2.5G and 3G wireless technologies. We also anticipate that in the United States and Canada the transition from 2G to 2.5G and 3G technologies will be driven by CDMA 3G (1xRTT) deployment for CDMA-based networks, and by GPRS/UMTS deployment for GSM and TDMA-based networks. In the Caribbean and Latin America, wireless subscriber growth continues at a high rate, largely due to the popularity and increased affordability of wireless communications services. In Brazil, capital spending by service providers has begun to shift from wireline communications networks to wireless communications networks. However, we anticipate a slowdown in wireless infrastructure investments in the Caribbean and Latin America region in 2002. Within the Europe, Middle East and Africa region, wireless subscriber growth has slowed dramatically over the last two years in many western European countries, largely due to very high wireless subscriber penetration levels. Investment decisions by wireless service providers in western Europe are being driven by anticipated growth in wireless data communications services. As a result, infrastructure spending in western Europe is currently primarily driven by the migration from GSM to GPRS and UMTS technologies, and the associated migration from circuit switching technologies to packet networking technologies. However, many wireless service providers in Europe have delayed this migration to 2.5G and 3G technologies as a result of financing constraints as well as the heavy debts they have incurred to obtain government licenses for 3G wireless networks. In the Asia Pacific region, we anticipate that capital spending by wireless service providers will be driven by migration to 3G technologies in Japan, and by continued growth in 2G technologies in China. Many countries in South and Southeast Asia have very low wireless subscriber penetration levels, and are expected to experience wireless subscriber growth over the next five years.
Our Wireless Networks customers are wireless service providers, and their customers are the subscribers of wireless communications services. The top 20 global wireless service providers collectively control a majority of all wireless subscribers around the world. We are currently focused on increasing our market presence among the top global wireless service providers. We expect to see the continued consolidation of wireless service providers, particularly in light of the large UMTS 3G license fees paid by wireless service providers in Europe, and the large capital investments they must make to build their 3G wireless networks. None of our Wireless Networks customers represented more than 10 percent of Nortel Networks consolidated revenues in 2001.
Our major competitors in the global wireless infrastructure business have traditionally included Ericsson, Lucent, Motorola, Inc., and Nokia Corporation. Nokia competes in the sale of GSM and UMTS equipment, whereas Lucent competes in the sale of CDMA and TDMA equipment. Motorola is a competitor in the sale of GSM and CDMA radio network access equipment. Ericsson competes in the sale of equipment for all of the major wireless communications technologies. More recently, Siemens has emerged as a competitor in the sale of GSM/UMTS systems, and Samsung Electronics Co., Ltd. has emerged as a competitor in the sale of CDMA systems.
The primary global factors of competition for our Wireless Networks products include:
11
We intend to continue to compete with our traditional competitors as the global market for wireless networking equipment migrates to 3G technologies. Given the significant capital expenditures required to build 3G wireless networks, we anticipate that the ability of wireless network infrastructure suppliers to offer customer financing will continue to be a key competitive factor. Although we expect to see continued consolidation in our industry, newer competitors, such as Siemens, Alcatel, Samsung, and Matsushita Electric Industrial Co., Ltd. (also known as Panasonic), may continue to emerge.
Optical Long-Haul Networks Segment
Our Optical Long-Haul Networks solutions include a broad range of long-distance optical networking products to address the needs of service providers, including local and long-distance telephone companies, Internet service providers, and other communications service providers. We refer you to “Optical Long-Haul Networks Segment – Customers” below. Long-distance optical networks transport data, voice, and multimedia communications between cities, countries, or continents by transmitting communications signals in the form of light particles/waves through fiber optic cables. Optical networking is the most common method for long-distance transport of communications signals between the various locations within a service provider’s network. We also offer our customers a variety of related engineering, installation, and support services.
Our optical long-haul networking solutions are designed to provide long-distance, high-capacity transport and switching of data, voice, and multimedia communications signals for operators of land-based and undersea (submarine) communications networks. These solutions include Dense Wavelength Division Multiplexing (DWDM) transmission solutions, synchronous optical transmission solutions, optical switching solutions, and network management software. We also offer our customers a wide range of optical components for long-distance optical networks. Optical components are the optical networking building blocks for our own products, and we also sell them to other network equipment manufacturers.
12
We are committed to providing next-generation optical line systems, including our OPTera Long Haul 5000 family of line systems, and next-generation optical switching solutions, including our OPTera Connect HDX system.
We are also working to develop new applications for switching systems in conjunction with ultra-long-reach transmission systems.
We are a leading provider of long-distance optical networking products to communications service providers around the world. We are also a provider of optical components to optical networking system and sub-system vendors around the world. From 1998 to 2000, the telecommunications industry experienced rapid growth in capital spending by service providers fueled by deregulation in many countries, strong economies, readily available sources of capital, and substantial growth in Internet and voice communications traffic. In 2001, capital spending in the area of long-distance optical networking equipment by service providers around the world decreased substantially. During 2001, with the rapid and severe industry and economic downturn and the capital markets decline, many service providers with excess capacity in their optical networks as a result of network expansions in prior years were able to delay plans for additional network expansions during 2001 by using their existing network capacity. As a result of the reduction in optical network expansions, optical system vendor demand for optical components also decreased substantially during 2001. In addition, the telecommunications industry experienced continuing consolidation in 2001, with some service providers experiencing financial difficulties, merger announcements by some other large service providers, and acquisitions of other “start-up” service providers. This also contributed to the reduction in service provider capital spending during 2001. We believe that the trend towards consolidation in the global telecommunications industry will continue in 2002.
We believe that end-user demand for network capacity from businesses and other organizations will continue to grow in 2002 and beyond. However, in 2002, we anticipate that the declines in service provider capital spending in the area of long-distance optical networking will continue, particularly in the United States, before they become less severe as service providers begin to utilize, and later exceed, their excess network capacity. Once service providers have exhausted their current excess network capacity and begin to engage in new network expansions, we anticipate that service provider demand for long-distance optical networking equipment, and optical system vendor demand for optical components, will both grow. We anticipate that the largest optical networking system and sub-system vendors will account for a significant proportion of all optical components purchases during 2002 and beyond, with many start-up and smaller customers struggling or faltering. In addition, economic stimulus measures by the United States and other countries, such as the proposed deregulation of the Local Access Transport Area (LATA), may provide new spending opportunities for service providers around the world. However, the timing and impact of these initiatives is difficult to predict.
13
The market for our Optical Long Haul Networks products is a global one, covering the United States and Canada, the Caribbean and Latin America region, the Europe, Middle East and Africa region, and the Asia Pacific region. We anticipate that pricing pressures will continue in all of these regions as service providers exhaust their existing network capacity prior to expansion and lease network capacity from others to a greater degree. In the United States and Canada, where the telecommunications industries have been deregulated for over a decade, we anticipate that network infrastructure construction by service providers will no longer be built in advance of market demand, as was the case before 2001. In the Caribbean and Latin America, where a few service providers account for a significant percentage of the telecommunications industry, the building of national optical network infrastructures is largely complete. Within the Europe, Middle East and Africa region, government-sponsored service providers and networking equipment suppliers enjoy favorable positions within many European countries, with off-shore vendors such as Nortel Networks frequently limited to secondary vendor positions with these service providers. In Europe, the building of pan-European optical networks by service providers is now mature, and many service providers have begun to focus on building their metropolitan and regional optical networks. Also, some service providers in Europe are experiencing capital constraints after having invested in government licenses for 3G wireless networks, and have postponed significant optical network expansions. The Asia Pacific region, where the telecommunications industry is continuing to undergo deregulation, experienced substantial growth in industry demand for long-distance optical networking equipment in 2001. As a result, there has been an increased focus on the Asia Pacific region by virtually all suppliers of long-distance optical networking equipment.
Our Optical Long-Haul Networks business is primarily focused on offering our long-distance optical networking products to service providers around the world. The service provider customers for our long-distance optical networking products include, local and long-distance telephone companies, Internet service providers, and other communications service providers. For a list of the types of service providers we offer our products to, we refer you to “Metro and Enterprise Networks – Customers” above. Nortel Networks is the primary customer for our optical components products. We also sell our optical components to other optical networking equipment suppliers in North America, Europe and Asia, some of whom are competitors in other areas of our business. We are currently focused on increasing our market presence with key global service provider customers. In particular, we intend to focus on certain large service providers, who we currently expect to account for a substantial proportion of service provider capital spending in 2002 and beyond. None of our Optical Long-Haul Networks customers represented more than 10 percent of Nortel Networks consolidated revenues in 2001.
Our major competitors in the sale of long-distance optical networking equipment include Alcatel, Ciena, Fujitsu Limited, Lucent, and Marconi. Market position in the global market for long-distance optical networking equipment fluctuates significantly on a quarter-by-quarter basis; however, Nortel Networks continues to be a leading global provider of long-distance optical networking equipment. Our major competitors in the sale of optical components include Agere Systems Inc., and JDS Uniphase Corporation.
The primary global factors of competition for our Optical Long-Haul Networks products include:
14
Sales and Distribution
All of our three operating segments use Nortel Networks direct sales force to market and sell to customers around the world. The Nortel Networks global sales force is divided into regional groups. The Americas sales force, primarily based in Richardson, Texas, supports customers all over the North and South American continents, including the Caribbean Islands. The Europe, Middle East and Africa sales force is based in Maidenhead, U.K., and the regional head office for the Asia Pacific region is based in Hong Kong. Within these regional sales groups, we have dedicated sales account teams for certain major service provider customers. These dedicated teams are located close to the customer’s main purchasing locations. In addition, within the regional sales groups are teams dedicated to our enterprise customers. These enterprise sales teams work directly with the top regional enterprises, and are also responsible for managing regional distribution channels. Nortel Networks also has centralized marketing, product management, and technical support teams dedicated to individual product lines that support the global sales and support teams.
In Asian countries, particularly in the People’s Republic of China, we also use agents to interface with our customers. In addition, we have some small, non-exclusive distribution agreements with distributors in the Caribbean and Latin America region, the Europe, Middle East and Africa region, and the Asia Pacific region. In the Metro and Enterprise Networks segment, we also use system integrators, value added resellers and stocking distributors as non-exclusive distribution channels for our products.
Product Standards, Certification, and Regulation
Our products are subject to equipment standards and certification in Canada, the United States and other countries. We design and manufacture our products to satisfy a variety of regulatory requirements and protocols established to, for instance, avoid interference among users of radio frequencies and to permit interconnection of equipment. For example, our equipment must satisfy the United States Federal Communications Commission emissions testing requirements, and must be certified to safety, electrical noise, and communications standards compliance. Different regulations and regulatory processes exist in each country. In order for our products to be used in some jurisdictions, regulatory approval and, in some cases, specific country compliance testing and re-testing may be required. The delays inherent in this regulatory approval process may force us to reschedule, postpone, or cancel introduction of products or new capabilities in certain geographic areas, and may result in reductions in our sales. The failure to comply with current or future regulations or changes in the interpretation of existing regulations in a particular country could result in the suspension or cessation of sales in that country or require us to incur substantial costs to modify our products to comply with the regulations of that country. To support our compliance efforts, we work with consultants and testing laboratories as necessary to ensure that our products comply with the requirements of Industry Canada in Canada, the Federal Communications Commission in the United States, and the European Telecommunications Standards Institute in western Europe, as well as with the various regulations of other countries.
Our products and operations are not subject to telecommunications regulation. However, the operations of our service provider customers are subject to extensive country-specific telecommunications regulations. Material changes in these regulations at any time or from time to time may affect capital spending by service providers around the world, and this may in turn affect the global market for networking solutions.
Financial Information by Operating Segment and Product Category
For financial information by operating segment and product category, see note 17 to the Consolidated Financial Statements, and “Results of operations – continuing operations – Revenues – Segment revenues” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Financial Information by Geographic Area
For financial information by geographic area, see “Geographic information” in note 17 to the Consolidated Financial Statements, and “Results of operations – continuing operations – Revenues – Geographic revenues” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
15
Working Capital
For a discussion of our working capital, see “Liquidity and capital resources” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, and note 8 to the Consolidated Financial Statements.
Sources and Availability of Materials
We are generally able to obtain sufficient materials and components from global sources to meet the needs of our three operating segments. In each of our operating segments, we:
Throughout 2001, we faced significantly different market conditions than we did in 1999 and 2000. During periods of high industry growth, as we experienced in 1999 and 2000, our objective was to obtain sufficient materials and components to produce enough product to meet demand. By contrast, in 2001, the industry was no longer in a period of high growth and faced supply surpluses and excess inventories existed in many areas. As a result, we were required to rapidly reduce our production in a number of areas, to write-off excess inventories, and to effectively manage our remaining inventories. From 1999 through 2001, we implemented a program to outsource most of our in-house manufacturing to contract manufacturers. During 2001, this initiative to outsource most of our in-house manufacturing, combined with our focus on lowering our production levels, assisted us in decreasing our inventory levels. At the same time that we decreased our inventory levels, we also developed systems in 2001 to maintain our flexibility to increase inventory levels as needed. We intend to continue to focus on inventory management, and expect to continue to purchase, manufacture, or otherwise obtain sufficient components and materials to supply our products, systems, and networks within customary delivery periods.
Seasonality
Traditionally, our business results in all of our operating segments were generally strongest in our fourth quarter, second strongest in our second quarter, third strongest in our third quarter, and the least strong in our first quarter, primarily due to the networking industry purchasing cycles exhibited by our customers. However, in 2001, we experienced a rapid and increasingly severe industry and economic downturn in the United States and elsewhere, and our customers faced restricted capital markets, which affected demand for our products and services, our customers’ traditional purchasing patterns, and the seasonality of our business. It is unclear whether, in the future, the timing of network expansions by our customers will follow any seasonal pattern, or whether our business results will return to our historical revenue patterns. See “Forward-looking statements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Strategic Alliances, Acquisitions, and Minority Investments
We use strategic alliances to deliver certain solutions to our customers. These alliances are typically formed to fill product or service gaps in areas that we do not consider to be part of our core businesses, including, but not limited to, the areas of non-core optical components, network computing, wireless appliances, and certain applications. Strategic alliances also augment our access to potential new customers. We intend to continue to pursue strategic alliances with businesses that offer the technology and/or resources that would enhance our ability to compete in existing markets or exploit new market opportunities. For information regarding the risks associated with strategic alliances, see “Forward-looking statements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
In 1999 and 2000, we acquired companies to further the expansion of our business and products. In 2001, with the sudden industry and economic downturn and the related capital markets decline, Nortel Networks acquisition activity slowed
16
significantly with only one acquisition completed in February 2001. In the future, we may consider selective opportunistic acquisitions of companies with resources and product or service offerings capable of providing us with additional strengths to help fulfill our vision of building the new, high-performance Internet.
We continue to hold minority investments acquired primarily in 1999 and 2000 in certain “start-up” businesses with technology, products, or services that, at the time of the investment, we believed had the potential to fulfill key existing or emerging market opportunities. This investment activity slowed in 2001 and we do not expect an increase in our minority investments in start-up businesses. We may make selective minority investments in start-up ventures where we believe the relationship could lay the foundation for future alliances that would support our customer solutions.
Research and Development
We intend to continue to make significant investments in our research and development activities. Our research and development activities—specifically, research, design and development, systems engineering, and other product development activities—focus on solutions in each of our operating segments. We refer you to the three “Product Development” discussions contained in the descriptions of our Metro and Enterprise Networks segment, our Wireless Networks segment, and our Optical Long-Haul Networks segment above. We also conduct network planning and systems engineering on behalf of, or in conjunction with, major customers. Although we derive many of our products from substantial internal research and development activities, we supplement this with technology acquired or licensed from third parties.
A substantial portion of Nortel Networks is dedicated to research and development, forming a core strength and a factor differentiating us from many of our competitors. As at December 31, 2001, we employed approximately 17,400 regular full-time research and development employees*. As at December 31, 2001, we employed approximately 7,500 regular full-time research and development employees in Canada, approximately 6,500 regular full-time research and development employees in the United States, and approximately 3,000 regular full-time research and development employees in Europe. We also conduct research and development activities through affiliated labs in other countries.
The following table sets forth our consolidated expenses for research and development for each of the last three fiscal years ended December 31:
Intellectual Property
Our intellectual property is fundamental to the business of each of our operating segments. We generate, maintain, and enforce a substantial portfolio of intellectual property rights, including trademarks, and an extensive and growing portfolio of patents covering significant innovations arising from research and development activities. In all of our operating segments, we use our intellectual property rights to protect our investments in research and development activities, to strengthen our leadership positions, to protect our good name, to promote our brand name recognition, to enhance our competitiveness, and to otherwise support our business goals and objectives.
On a consolidated basis, we have approximately 2,600 United States patents and approximately 3,000 patents in other countries. In addition, we have more than 6,000 pending patent applications worldwide. Approximately 30 percent of our patents relate to our Metro and Enterprise Networks segment, approximately 18 percent relate to our Wireless Networks
17
segment, approximately 12 percent relate to our Optical Long-Haul Networks segment, and approximately 40 percent span multiple operating segments or relate to other areas. Our patents outside of the United States are primarily counterparts to our United States patents. In 2001, we were granted 499 United States patents, continuing our plan of increasing our patent holdings. We have entered into some mutual patent cross-license agreements with several major corporations to enable each party to operate without risk of a patent infringement claim from the other. In addition, we are actively licensing certain of our patents and/or technology to third parties. We also occasionally license single patents or groups of patents from third parties.
Our trademark and trade name, Nortel Networks, is one of our most valuable assets. We sell our products primarily under the Nortel Networks brand name. We have registered the Nortel Networks trademark, and many of our other trademarks, in countries around the world. On a consolidated basis, we own approximately 140 registered trademarks in the United States, and approximately 2,000 registered trademarks in other countries. In addition, we have more than 360 pending trademark registrations worldwide.
Employee Relations
At December 31, 2001, we employed approximately 52,600 regular full-time employees,** including approximately:
We also employ individuals on a part-time basis and use the services of independent contractors. At December 31, 2001, we employed approximately 1,000 regular part-time employees, and engaged the services of approximately 900 independent contractors. As part of our resizing activities to further reduce our cost structure and streamline operations, we notified for termination and provisioned for approximately 36,100 employees during 2001. See “Special charges” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, and note 7 to the Consolidated Financial Statements. In addition, the divestiture of non-core businesses completed or entered into in 2001 resulted in additional employee reductions.
Labor contracts cover approximately 5 percent of our employees worldwide. Five labor contracts cover approximately 13 percent of our employees in Canada. Two of these five labor contracts cover approximately 74 percent of Canadian unionized employees and will expire in 2004. Two of the remaining three contracts expire in 2003, affecting approximately 8 percent of Canadian unionized employees. The remaining contract expires in 2008, affecting approximately 18 percent of Canadian unionized employees. Labor contracts cover approximately 4 percent of our employees in Europe and all of our employees in Brazil. The labor contracts generally have a one-year term in Europe and Brazil, and primarily relate to remuneration. We have no labor contracts in the United States.
We believe our employee relations are generally positive. We are currently focused on rebuilding employee morale following the substantial workforce reductions and other restructuring activities that we announced in 2001. Although the recruitment and retention of technically skilled employees in recent years was highly competitive in the global networking industry, current economic conditions have lessened the competition for skilled employees in our industry. We do, however, believe that our ability to recruit and retain skilled employees will continue to be critical to our future success. See “Forward-looking statements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
18
Environmental Matters
Our manufacturing and research operations are subject to a wide range of environmental protection laws in various jurisdictions around the world. We seek to operate our business in compliance with applicable environmental laws, and have a corporate environmental management system standard and an environmental protection program to promote compliance. We also have a periodic, risk-based, integrated environment, health and safety audit program. As part of our environmental policy, we attempt to evaluate and assume responsibility for the environmental impacts of our products throughout their life cycles. Our environmental program focuses on design for the environment, and supply chain and packaging reduction issues. We work with our suppliers and other external groups to encourage the sharing of non-proprietary information on environmental research. For additional information regarding our environmental matters, see “Contingencies-Environmental matters” in note 19 to the Consolidated Financial Statements.
Risk Factors
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING INFORMATION THAT IS SUBJECT TO IMPORTANT RISKS AND UNCERTAINTIES. THE RESULTS OR EVENTS PREDICTED IN THESE STATEMENTS MAY DIFFER MATERIALLY FROM ACTUAL RESULTS OR EVENTS. RESULTS OR EVENTS COULD DIFFER FROM CURRENT EXPECTATIONS AS A RESULT OF A WIDE RANGE OF RISK FACTORS. FOR INFORMATION REGARDING SOME OF THE RISK FACTORS INVOLVED IN OUR BUSINESS AND OPERATIONS, SEE “FORWARD-LOOKING STATEMENTS” IN MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
19
ITEM 2. PROPERTIES
At December 31, 2001, we operated 292 sites around the world occupying approximately 22.5 million square feet. The following table sets forth additional information regarding these sites:
Seventeen percent of our facilities are primarily used by our Metro and Enterprise Networks segment, 12 percent of our facilities are primarily used by our Wireless Networks segment, and 8 percent of our facilities are primarily used by our Optical Long-Haul Networks segment. The remaining 63 percent of our facilities serve the needs of more than one of our operating segments and/or corporate functions.
As part of our restructuring and resizing activities in 2001, we discontinued our access solutions operations, we completed a number of divestitures and outsourcing transactions, and we amended certain credit agreements. See “Developments in 2001” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. These activities resulted in a substantial reduction in the number of sites and square footage of our global facilities to align ourselves with current market conditions. In addition, our amended credit agreements provide for the granting of security over substantially all of Nortel Networks physical assets, including real estate assets in North America, in the event that Nortel Networks Limited’s United States senior unsecured long-term debt rating falls below investment grade. For additional details, see note 8 to the Consolidated Financial Statements, and “Liquidity and capital resources – Sources of liquidity” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. We believe our plants and facilities are suitable and adequate, and have sufficient productive capacity to meet our current needs.
ITEM 3. LEGAL PROCEEDINGS
For a discussion of our material legal proceedings, see “Legal proceedings” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of Nortel Networks Corporation are appointed, and may be removed, by the Board of Directors of Nortel Networks Corporation. As of February 28, 2002, the names of the executive officers of Nortel Networks Corporation, their ages, offices currently held, and year of appointment thereto were as follows:
All the above-named executive officers of Nortel Networks Corporation have been employed in their current position or other senior positions with Nortel Networks during the past five years, except as follows:
21
22
PART II
The common shares of Nortel Networks Corporation are listed and posted for trading on the New York Stock Exchange in the United States and on The Toronto Stock Exchange in Canada. The following table sets forth the high and low sale prices of the common shares of Nortel Networks Corporation since May 1, 2000, and the common shares of Nortel Networks Limited before May 1, 2000, as reported on the New York Stock Exchange composite tape and on The Toronto Stock Exchange. All figures have been adjusted to reflect the division of the common shares of Nortel Networks Corporation on a two-for-one basis effective at the close of business on May 5, 2000.
On February 28, 2002, the last sale price on the New York Stock Exchange was $5.07 and on The Toronto Stock Exchange was Canadian $8.05.
On February 28, 2002, over 209,400 registered shareholders held 100 percent of the outstanding common shares of Nortel Networks Corporation. This included the Canadian Depository for Securities and the Depository Trust Company, two clearing corporations, which held a total of approximately 93.9 percent of the common shares of Nortel Networks Corporation on behalf of other shareholders.
Dividends
On June 15, 2001, Nortel Networks Corporation announced that its Board of Directors decided to discontinue the declaration and payment of common share dividends. As a result, dividends have not been declared and paid on Nortel Networks Corporation common shares after June 29, 2001, and future dividends will not be declared unless and until the Board of Directors decides otherwise. On July 26, 2001, the Board of Directors of Nortel Networks Corporation suspended the operation of the Nortel Networks Corporation Dividend Reinvestment and Stock Purchase Plan.
In the first and second quarter of 2001, Nortel Networks Corporation declared and paid a cash dividend of $0.01875 per common share. This represents a total dividend of $0.0375 per common share for 2001 and an aggregate payment of $123 million. In 2000, after adjusting for the May 5, 2000 stock split:
This represents a total dividend of $0.075 per common share for 2000 and an aggregate payment of $223 million.
23
The amended and restated credit agreements entered into on December 20, 2001 by Nortel Networks Limited and Nortel Networks Inc., the principal operating subsidiaries of Nortel Networks Corporation, restrict the ability of Nortel Networks Limited and its material subsidiaries, including Nortel Networks Inc., to pay cash dividends or make loans or advances to Nortel Networks Corporation. Nortel Networks Limited is permitted to pay cash dividends to Nortel Networks Corporation in certain circumstances, including to fund interest payments due on Nortel Networks Corporation’s outstanding 4.25% Convertible Senior Notes Due 2008, as long as Nortel Networks Limited is in compliance with specified covenants contained in the credit agreements.
Canadian Tax Matters
Under the United States-Canada Income Tax Convention (1980), or the “Convention,” Canadian withholding tax of 15 percent generally applies to the gross amount of dividends (including stock dividends) paid or credited to beneficial owners of Nortel Networks Corporation shares:
The Convention provides an exemption from withholding tax on dividends paid or credited to certain tax-exempt organizations that are resident in the United States for purposes of the Convention. Persons who are subject to the United States federal income tax on dividends may be entitled, subject to certain limitations, to either a credit or deduction with respect to Canadian income taxes withheld with respect to dividends paid or credited on Nortel Networks Corporation shares.
Sales or Other Dispositions of Shares
Gains on sales or other dispositions of Nortel Networks Corporation shares by a non-resident of Canada are generally not subject to Canadian income tax, unless the holder realizes the gains in connection with a business carried on in Canada. A gain realized upon the disposition of Nortel Networks Corporation shares by a resident of the United States that is otherwise subject to Canadian tax may be exempt from Canadian tax under the Convention. Where Nortel Networks Corporation shares are disposed of by way of an acquisition of such shares by Nortel Networks Corporation, other than a purchase in the open market in the manner in which shares would normally be purchased by any member of the public in the open market, the amount paid by Nortel Networks Corporation in excess of the paid-up capital of such shares will be treated as a dividend, and will be subject to non-resident withholding tax as described above under the heading “Dividends.”
Sales of Unregistered Securities
On November 20, 2001, Nortel Networks Corporation acquired Candlestick Networks, Inc. and issued approximately 1.7 million common shares of Nortel Networks Corporation to the Candlestick stockholders in exchange for all of the issued and outstanding shares of Candlestick common stock and preferred stock. Nortel Networks Corporation also assumed all of the outstanding Candlestick stock options and reserved an additional approximate 1.3 million common shares for issuance upon the exercise of these options. Of these stock options, options to purchase a maximum of approximately 0.3 million common shares of Nortel Networks Corporation are, or may become, exercisable. Nortel Networks Corporation placed 15 percent of the 1.7 million common shares issued on closing into escrow in connection with Candlestick’s indemnification obligations. The escrow agent and Nortel Networks Corporation may cancel any or all of these common shares in future periods in response to indemnification claims by Nortel Networks Corporation. All of the common shares that Nortel Networks Corporation has issued, or may in the future issue, to the former Candlestick security holders are deemed to be exempt from registration under the Securities Act of 1933, as amended. This exemption relies on Section 3(a)(10) of the Securities Act, and is based on Nortel Networks Corporation’s receipt of a permit under Section 25121 of the California Corporations Code.
24
During the fourth quarter of 2001, Nortel Networks Corporation issued an aggregate of 110,816 common shares upon the exercise of options granted under the Nortel Networks/BCE 1985 Stock Option Plan and the Nortel Networks/BCE 1999 Stock Option Plan. The common shares issued on the exercise of these options were issued outside of the United States to BCE in connection with options that expired unexercised or were forfeited. The common shares issued are deemed to be exempt from registration under the United States Securities Act of 1933, as amended, pursuant to Regulation S. All funds received by Nortel Networks Corporation in connection with the exercise of stock options granted under the two Nortel Networks/BCE stock option plans are transferred in full to BCE pursuant to the terms of the May 1, 2000 plan of arrangement, except for nominal amounts paid to Nortel Networks Corporation to round up fractional entitlements into whole shares. Nortel Networks Corporation keeps these nominal amounts and uses them for general corporate purposes.
25
ITEM 6. SELECTED FINANCIAL DATA (UNAUDITED)
26
You should read this section in conjunction with the accompanying audited consolidated financial statements and notes prepared in accordance with United States generally accepted accounting principles. This section adds additional analysis of our operations and current financial condition and also contains forward-looking statements and should be read in conjunction with the factors set forth below under “Forward-looking statements”. All dollar amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are in millions of United States dollars unless otherwise stated.
Where we say “we,” “us,” “our,” or “Nortel Networks,” we mean Nortel Networks Corporation and its subsidiaries.
Business overview
We are a leading global supplier of products and services that support the Internet and other public and private data, voice, and multimedia communications networks, using terrestrial and wireless technologies, which we refer to as “networking solutions”. With our networking solutions, we are focused on providing the infrastructure and applications for high performance networks, as technology transforms the way we communicate and conduct business. We have a technology focus, with a substantial portion of Nortel Networks dedicated to research and development, forming a core strength and a factor differentiating us from our competitors. Our research and development efforts are focused on delivering carrier-grade infrastructure, enabling valuable services for our customers, reducing network costs, and transforming traditional voice-communications networks into cost effective networks supporting data, voice and multimedia communications.
We re-organized our operations during the fourth quarter of 2001 to focus on providing seamless networking products and service capabilities across three core business areas and three segments: Metro and Enterprise Networks; Wireless Networks; and Optical Long-Haul Networks. These products and service solutions are used by service provider and enterprise customers, including incumbent and competitive local exchange carriers, interexchange carriers, service providers with global businesses, wireless service providers, Internet service providers, application service providers, hosting service providers, resellers, cable television companies, other communications service providers, large businesses and their branch offices, small businesses, and home offices, as well as government, education, and utility organizations.
Our Metro and Enterprise Networks segment includes a range of Optical Ethernet solutions, packet switching and routing solutions, such as data switching systems, aggregation products, virtual private network gateways, and routers, and circuit to packet network solutions, such as enterprise telephone systems, digital switching systems, business solutions and applications, and network management software, together with related professional services. Our Wireless Networks segment solutions support the Time Division Multiple Access, or TDMA, Code Division Multiple Access, or CDMA, Global System for Mobile communications, or GMS, General Radio Packet Standard, or GPRS, and Universal Mobile Telecommunications Systems, or UMTS, standards, to enable end users to be mobile while they send and receive voice and data communications using a wireless device, and include radio access network equipment, key network elements of which are base station transceivers and base station controllers, core network equipment, key network elements of which are mobile switching centers and home location registers, and related professional services. Our Optical Long-Haul Networks segment includes optical long-haul networking solutions designed to provide long-distance, high-capacity transport and switching of data, voice, and multimedia communications signals for operators of land-based and submarine communications networks, including Dense Wave Division Multiplexing (DWDM) transmission solutions, synchronous optical transmission solutions, optical switching solutions, and network management software, optical components for long-distance optical networks, including optical transmitters, optical receivers, lasers, tunable lasers, amplifiers, pump modules, integrated circuits, and other modules and devices for long-haul optical networking, and related engineering, installation, and support services.
Nortel Networks Corporation’s common shares are publicly-traded on the New York and Toronto stock exchanges under the symbol “NT”. Nortel Networks Limited is our principal direct operating subsidiary. Nortel Networks Corporation holds all of Nortel Networks Limited’s outstanding common shares but none of its outstanding preferred shares. Acquisitions involving any share consideration are completed by Nortel Networks Corporation, while acquisitions involving only cash consideration are generally completed by Nortel Networks Limited or one of its direct subsidiaries.
27
Core market refocus and associated restructuring
During 2001, in light of the significant downturn in both the telecommunications industry and the economic environment, and capital market trends impacting our operations and expected future growth rates, we implemented our work plan to streamline operations and activities around our core markets and leadership strategies. This work plan was adjusted during the year to reflect the continued decline in the industry and economic environment, and in the capital markets. In connection with our work plan, we took the following actions to position and strengthen our business:
Intangible assets write down
In light of the significant negative industry and economic trends impacting our operations and expected future growth rates, and the capital markets’ adjustment of technology valuations, we performed an assessment of the carrying values of intangible assets recorded in connection with our various acquisitions as part of our review of financial results during the three months ended June 30, 2001. As a result, we recorded a $12,422 (pre-tax) write down of intangible assets in the three months ended June 30, 2001 (See “Special charges” for additional information).
28
Legal matters
Subsequent to the February 15, 2001 announcement in which Nortel Networks provided revised guidance for financial performance for the fiscal year and first quarter 2001, Nortel Networks Corporation and certain of its then current officers and directors were named as defendants in numerous purported class action lawsuits. These lawsuits allege, among other things, violations of United States federal and Canadian provincial securities laws. Securities regulatory authorities in Canada and the United States are also reviewing these matters. In addition, a class action lawsuit was filed on behalf of shareholders who acquired the securities of JDS Uniphase Corporation between January 18, 2001 and February 15, 2001, alleging violation of the same United States federal securities laws as the other lawsuits in connection with our acquisition of certain of JDS Uniphase Corporation’s assets in exchange for common shares of Nortel Networks Corporation. On December 21, 2001, a purported class action lawsuit was filed on behalf of certain participants and beneficiaries of the Nortel Networks Long-Term Investment Plan, who made or maintained plan investments in Nortel Networks Corporation’s common shares, under the United States Employee Retirement Income Security Act (See “Legal proceedings” for additional information).
Results of operations — continuing operations
Revenues
Segment revenues
The following table sets forth revenues by segment for the years ended December 31:
Geographic revenues
The following table sets forth revenues by geographic region for the years ended December 31:
For the years ended December 31, 2001, 2000, and 1999, revenues in the United States by point of origin (the location of the selling organization) were $9,818, $18,520, and $13,242, respectively.
29
Consolidated
In 2001, the telecommunications industry underwent a significant adjustment, particularly in the United States. Following a period of rapid infrastructure build-out and strong economic growth in 1999 and 2000, we saw a continued tightening in the capital markets and slowdown in the telecommunications industry throughout 2001. This resulted in lower capital spending by industry participants and substantially less demand for our products and services as service providers focused on maximizing their return on invested capital. As a result, our consolidated revenues declined substantially, primarily in the Optical Long-Haul Networks segment and the circuit to packet voice networks portion of the Metro and Enterprise Networks segment, due to our customers’ change in focus from building new networks to conserving capital and/or increasing the capacity utilization rates and efficiency of existing networks, and reducing costs. We expect that the severe lack of available funding from the capital markets, high debt levels of many service providers, bankruptcies of certain service providers, excess network assets, excess and shared bandwidth capacity, and the compounding impact of economic concerns will continue to constrain capital spending by service providers. It is difficult to predict the duration or severity of this industry adjustment, as growth in industry spending is not expected to occur until economic concerns have subsided and the anticipated rationalization of the telecom industry is well underway. For the year 2002, we currently expect a gradual growth in revenues beginning in the second quarter. However, market visibility remains limited given the uncertainty of the economic downturn and its impact on our customers’ business and spending plans. We do not expect that results of operations for any quarter will necessarily be consistent with our quarterly historical profile or indicative of results to be expected for future quarters.
The significant adjustment in the telecommunications industry, which was initially felt and was most severe in the United States, also impacted Europe, the Caribbean and Latin America region, and the Asia Pacific region during 2001. Overall revenues declined substantially across all regions, with the exception of the Asia Pacific region, in 2001 compared to 2000. The Asia Pacific region saw substantial growth during this period due to considerable sequential growth in the first half of 2001, primarily as a result of growth in the People’s Republic of China as contracts entered into during 2000 were completed. However, we experienced a substantial sequential decline in the second half of 2001 in the Asia Pacific region. We expect that revenues from the People’s Republic of China will be affected by the expected break-up of a major Chinese service provider. The decline in Europe reflects a substantial sequential decline in the second quarter of 2001 and significant sequential declines in the third and fourth quarters of 2001. The decline in the Caribbean and Latin America region reflects substantial sequential declines in the second and third quarters of 2001. The Unites States was essentially flat sequentially in the fourth quarter of 2001 following three quarters of substantial sequential declines in 2001.
The substantial revenue growth in 2000 compared to 1999 was due to substantial growth in the Optical Long-Haul Networks segment, significant growth in the Metro and Enterprise Networks segment, and substantial growth in the Wireless Networks segment. The substantial revenue growth was primarily due to substantial increases in the United States and Europe. Consolidated revenues increased as a result of increases in sales volume and new product introductions, slightly offset by price reductions.
Metro and Enterprise Networks
The substantial decline in revenues in 2001 compared to 2000 was due to substantial declines in sales of the circuit to packet voice networks and metro optical portions of this segment, and a significant decline in the packet switching and routing portion of this segment. The substantial decrease in sales of the circuit to packet voice networks portion of this segment was primarily the result of reduced demand in the interexchange carrier market due to the significant adjustment in the telecom industry, industry consolidation, tightened capital markets, and the maturing of this portion of the segment The substantial decrease in sales of the metro optical portion of this segment related to declines in sales volumes of mature optical products that have a metro application. The significant decline in sales of the packet switching and routing portion of this segment was primarily due to a decline in demand for mature products in this portion of the segment, compounded by the continued industry adjustment as customers delayed the purchase of next generation products. The circuit to packet voice networks for the service providers and enterprises portion of this segment continues to form a substantial portion of the overall sales for this segment. As data, voice, and multimedia communications technologies continue to converge, and service providers as well as enterprises look for ways to maximize the effectiveness of their existing networks while reducing ongoing capital expenditures and operating costs, we anticipate that communications networks will use packet-based technologies. However, the timing of this progression in the short term is unclear as a result of the continuing industry
30
adjustment. The substantial decline in overall segment revenues was primarily due to a substantial decline in the United States, a significant decline in Europe, and substantial declines in Canada and the Caribbean and Latin America region.
The significant growth in revenues in 2000 compared to 1999 was due to substantial growth in sales of the metro optical portion of this segment, an increase in sales of the circuit to packet voice networks portion of this segment, and significant growth in sales of the packet switching and routing portion of this segment. The significant growth in overall segment revenues was primarily due to significant growth in the United States and Europe.
Wireless Networks
The increase in revenues in 2001 compared to 2000 was primarily due to substantial revenue increases during the first half of 2001, driven by growth in the United States and the Asia Pacific region, as major customers continued their network expansion programs. This increase was partially offset by declines in the United States during the second half of 2001, compared to 2000, and declines in the Caribbean and Latin America region in the second and third quarters of 2001, compared to the same periods in 2000, as a result of deterioration in customers’ financial condition, our providing limited, incremental customer financing as a result of the market conditions, and the decision of many wireless service providers to delay certain capital expenditures. The overall growth in Wireless Networks segment revenues in the United States was primarily generated by sales of Code Division Multiple Access, or CDMA, and Time Division Multiple Access, or TDMA, technologies. The overall growth in the Asia Pacific region was primarily generated by sales of Global System for Mobile communications, or GSM, technology. Universal Mobile Telecommunications System, or UMTS, and CDMA 3G technology sales are expected to represent a larger proportion of our total Wireless Networks segment revenues as third generation, or 3G, technologies gain a greater foothold in the market and as GSM and TDMA sales slow, comparatively. However, the timing of changes in revenues in the short term from the different wireless technologies has become increasingly difficult to predict as a result of the continuing industry and capital markets adjustments and the complexities and potential for delays in implementation of 3G network deployments. The increase in overall segment revenues was primarily due to a significant increase in the United States and a substantial increase in the Asia Pacific region, partially offset by substantial declines in the Caribbean and Latin America region and Europe.
The substantial growth in revenues in 2000 compared to 1999 was due to an increase in wireless network build-outs, primarily by our major United States customers. The substantial increase in overall segment revenues was primarily due to substantial growth in the United States, Europe, and the Caribbean and Latin America region.
Optical Long-Haul Networks
The substantial decline in revenues in 2001 compared to 2000 was primarily the result of substantial reductions in capital spending, primarily by our major United States customers. Our major customers in this segment focused on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks, and we expect that any additional capital spending by those customers will be increasingly directed to opportunities that enhance customer performance, revenue generation, and cost reduction in the near term. We expect that customers in this segment will continue to focus on route by route activities and adding channels to existing networks in the short term, while building out networks for increased bandwidth will remain longer term projects. Sales for the Optical Long-Haul Networks segment are primarily based on network build-outs and, as such, generally include a number of long-haul products packaged together in an end-to-end solution. As a result, volatility in this segment typically results in a corresponding increase or decline in overall segment sales as almost all products within the segment are generally affected in the same manner. Our revenues in the first quarter of 2001 reflected the then in-process network build-outs that had begun in 2000. However, when the telecom industry began experiencing the significant adjustment and the capital markets tightened, our customers reduced their purchases significantly as they focused on reducing existing inventory levels to complete existing network build-outs and on improving the efficiency of existing networks as described above. The continuing telecommunications industry consolidation in 2001 also contributed to the reduction in service provider capital spending during 2001. Overall, a large redeployment of assets occurred in this segment of the industry in 2001 primarily due to significant excess inventories, and is expected to continue to a certain extent into 2002. This redeployment, in conjunction with the continuing telecommunications industry consolidation, resulted in significant pricing pressures in 2001. Due to the severe reduction, in number and size, of new network build-outs during 2001, we experienced a substantial decline in this segment compared to 2000. Also, due to the nature of this segment we expect that the Optical Long-Haul Networks segment will be one of the last
31
to recover from the significant adjustment in the telecom industry. The substantial decline in Optical Long-Haul Networks segment revenues was primarily due to substantial declines in the United States, Europe, Canada, and the Caribbean and Latin America region, partially offset by substantial growth in the Asia Pacific region.
The substantial growth in revenues in 2000 compared to 1999 was due to substantially increased network build-out activity, primarily by our United States customers, as industry participants competed in the deregulated environment and positioned themselves for the then anticipated increased demand for network capacity. The build-out activity was aided by the increased flow of funds from capital markets to this sector during this period. The substantial increase in segment revenues was primarily due to substantial increases in the United States, Europe, and the Caribbean and Latin America region.
Gross profit and gross margin
The following table sets forth gross profit and gross margin for the years ended December 31:
Gross profit decreased substantially in 2001 compared to 2000 due to substantial declines in revenues and gross margin. The decrease in gross margin was due to substantial decreases in gross margins across all segments. The overall decrease in gross margin was primarily due to the following factors: (i) approximately $1,500 of increased provisions, related to the entire supply chain and contract and customer settlements, as a result of the significant adjustment in the telecommunications industry; (ii) our fixed cost structure that was not reflective of the lower sales volumes in 2001; (iii) pricing pressures across certain products and services, primarily in the Optical Long-Haul Networks segment, resulting from increased competition in the current economic environment; and (iv) shifts in the geographic mix of sales from the United States to Europe and the Asia Pacific region, where we generally earn lower gross margins. Sales in the United States accounted for approximately 49% of overall sales in 2001, compared to approximately 60% in 2000.
While we cannot predict to what extent pricing pressures will continue, or whether the shift in the geographic mix of our sales will continue, we expect that our work plan, when completed, will result in a cost structure that is more reflective of the current industry and economic environment. In addition, we believe that our current provision levels related to the entire supply chain reflect both current and anticipated future market demand. As a result, we expect that overall gross margin for the full year 2002 will be substantially higher compared to full year 2001. See “Forward-looking statements” for factors that may affect our gross margins.
Gross profit increased substantially in 2000 compared to 1999, primarily due to a substantial increase in revenues. Overall, gross margin increased in 2000 by 0.8 percentage points compared to 1999, reflecting comparable pricing for certain of our products and a similar product mix. Although competitive pricing pressures existed during 2000, particularly with respect to sales in the Wireless Networks segment, overall we were able to mitigate such pricing pressures through increased sales of higher-margin products and manufacturing and other cost-reduction programs.
32
Operating expenses
Selling, general and administrative expense
The following table sets forth selling, general and administrative, or SG&A, expense and SG&A expense as a percentage of revenues for the years ended December 31:
SG&A expense increased in 2001 compared to 2000, reflecting costs incurred during the first half of 2001 resulting from the increased investment in North American and international markets across all segments during the second half of 2000 to support our revenue growth during that period and the then anticipated revenue growth for 2001. SG&A expense increase also resulted from increased provisions of approximately $1,067 related to various customer receivables and financings, due to the worsening financial position of certain customers following the significant adjustment in the telecom industry. Excluding the impact of increased provisions recorded during 2001, SG&A expense in absolute dollars declined significantly. SG&A expense, in absolute dollars, is expected to decline sequentially on a quarterly basis during 2002 as the full impact of our work plan is realized. We expect that SG&A expense, as a percentage of revenues, will decline to our traditional quarterly levels during the second half of 2002.
The considerable increase in SG&A expense in 2000, compared to 1999, reflected increased investment in our sales force to support our global growth and strategic acquisitions, and customer financing provisions as a result of the significant increase in funded customer financings.
Research and development expense
The following table sets forth research and development, or R&D, expense and R&D expense as a percentage of revenues for the years ended December 31:
R&D expense decreased significantly in 2001 compared to 2000, reflecting the impact of initiatives undertaken by us to focus our spending on key potential growth areas. R&D expense represented our planned investment in our next generation core products across all segments. R&D expense, in absolute dollars, is expected to decline for full year 2002, compared to full year 2001, based on our expected quarterly R&D expense of approximately $625, not including any potential additional investments in R&D with respect to future strategic opportunities and related new products.
The considerable increase in R&D expense in 2000, compared to 1999, was due to increased investment in research and development, primarily attributable to new equipment, process development, and advanced capabilities and services for a broad array of applications across all segments.
33
In-process research and development expense and amortization of intangibles
The following table sets forth in-process research and development, or IPR&D, expense and amortization of intangibles for the years ended December 31:
IPR&D expense
In 2001, IPR&D expense reflected the acquisition of JDS Uniphase Corporation’s Zurich, Switzerland-based subsidiary, and related assets in Poughkeepsie, New York, or the 980 NPLC Business. In 2000, IPR&D expense primarily reflected the acquisitions of Qtera Corporation, Alteon Websystems, Inc., Xros, Inc., and CoreTek, Inc. In 1999, IPR&D expense related primarily to the acquisitions of Shasta Networks, Inc. and Periphonics Corporation.
Amortization of intangibles
Acquired technology
The amortization of acquired technology for 2001 reflected the charge related to the acquisitions of Bay Networks, Inc., Alteon, and Clarify Inc. The amortization of acquired technology for 2000 and 1999 primarily reflected the charge related to the acquisition of Bay Networks. As at December 31, 2001 and 2000, the remaining capitalized amount of acquired technology — net was $285 and $1,125, respectively.
Goodwill
The amortization of goodwill for 2001 primarily reflected the charges related to the acquisitions of Bay Networks, Alteon, Xros, Qtera, Clarify, and the 980 NPLC Business. The amortization of goodwill for 2000 primarily reflected the charges related to the acquisitions of Bay Networks, Qtera, Xros, Clarify, and Alteon. The amortization of goodwill for 1999 primarily reflected the charges related to the acquisition of Bay Networks. As at December 31, 2001 and 2000, the remaining capitalized amount of goodwill — net was $2,810 and $16,833, respectively (See “Special charges” for additional information).
The adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, or SFAS 142, changes the accounting for goodwill from an amortization method to an impairment-only approach and, as a result, the amortization of goodwill ceased upon adoption of this Statement effective January 1, 2002. As a result, quarterly amortization expense of approximately $450 will no longer be incurred beginning with the first quarter of 2002. We will be performing the first of the required impairment tests under SFAS 142 during the first half of 2002 and have not yet determined the effect of adoption on our business, results of operations, or financial condition.
Special charges
For 2001, we recorded special charges of $15,781 related to both restructuring activities and an intangible assets write down.
34
Restructuring activities
During 2001, in light of the significant downturn in both the telecommunications industry and the economic environment, and capital market trends impacting our operations and expected future growth rates, we implemented our work plan to streamline our operations and activities around our core markets and leadership strategies. We adjusted our work plan during the year to reflect the continued decline in the industry and economic environment, and in the capital markets.
Workforce reduction charges of $1,361 were related to the cost of severance and benefits associated with the approximately 36,100 employees notified of termination. Of the 36,100 employees notified by December 31, 2001, approximately 13,900 were direct employees performing manufacturing, assembly, test and inspection activities associated with the production of our products, and approximately 22,200 were indirect sales, marketing, and administrative employees, and manufacturing managers. The workforce reduction was primarily in North America and the United Kingdom and extended across all of our segments. As at December 31, 2001, we have made cash payments of $975. The remaining cash payments of $400 are expected to be substantially completed by the end of 2002. We will incur an additional charge in the first quarter of 2002, and may incur further charges in the second quarter of 2002, related to the completion of previously announced workforce reductions and related charges, upon compliance with certain regional legislation in Europe, as required.
In conjunction with the above noted workforce reduction, we identified a number of leased and owned facilities comprised of office, warehouse, and manufacturing space, as well as leased manufacturing equipment, that were no longer required. As a result, we recorded net lease costs of approximately $757. The costs primarily related to our future contractual obligations under operating leases. Offsetting the total lease charge is approximately $506 in expected sublease revenue on leases that we cannot terminate. We also wrote down the net carrying value of specific owned facilities across all segments within North America, and the United Kingdom. The write down of approximately $95 reflects the net realizable value based on market assessments for general purpose facilities. Contract settlement costs included negotiated settlements of approximately $126 to either cancel contracts or renegotiate existing contracts across all of our segments. As at December 31, 2001, we have made cash payments of $110 in respect of lease and contract settlement costs. The remaining cash payments of $773 for lease and contract settlement costs are expected to be substantially completed by the end of 2004.
Plant and equipment write downs of approximately $440 consisted of the write down of leasehold improvements and certain information technology equipment associated with the exiting of the above noted leased and owned facilities.
As a result of the significant negative industry and economic trends impacting our operations and expected future growth rates, we performed assessments of certain plant and equipment assets as part of our review of financial results during 2001. The conclusion of these assessments resulted in a write down of certain plant and equipment within global operations, a function that supports all of our segments, and within the Optical Long-Haul Networks segment, of approximately $435.
Within global operations, it was determined that there was excess test equipment at a number of system houses that would no longer be required as a result of the industry and economic environment. As a result, we recorded a charge of approximately $66 to write down the value of this equipment to its net realizable value based on the current fair value for this type of specialized equipment. We expect to dispose of this equipment by the end of the second quarter of 2002.
Within the Optical Long-Haul Networks segment, we determined that there was excess manufacturing equipment at a number of facilities that would no longer be required as a result of the industry and economic environment. As a result, we recorded a charge of approximately $278 to write down the value of this equipment to its net realizable value based on the current fair market value for this type of specialized equipment. We expect to dispose of this equipment by the end of the second quarter of 2002. We also wrote down the net carrying value of a specialized manufacturing facility within the Optical Long-Haul Networks segment for the production of optical components within North America. The write down of approximately $91 reflects the net realizable value based on market assessments for a general purpose facility.
The intangible asset write-off of $106 is related to the remaining net book value of goodwill associated with our prior acquisitions of MICOM Communications Corp. and Dimension Enterprises, Inc. As part of our work plan to streamline our business, we have made the decision to exit all technologies and consulting services related to these prior acquisitions.
35
The financial results related to these prior acquisitions were not material to our business, results of operations, and financial condition.
Write down of intangible assets
As part of our review of financial results during the three months ended June 30, 2001, we performed an assessment of the carrying values of intangible assets recorded in connection with our various acquisitions. The assessment during that period was performed in light of the significant negative industry and economic trends impacting our operations and expected future growth rates, and the adjustment of technology valuations. The conclusion of that assessment was that the decline in market conditions within our industry was significant and other than temporary. As a result, we recorded a $12,422 write down of intangible assets in the three months ended June 30, 2001, based on the amount by which the carrying amount of these assets exceeded their fair value. The write down was primarily related to the goodwill associated with the acquisition of Alteon within the Metro and Enterprise Networks segment, and the acquisitions of the 980 NPLC Business, Xros, and Qtera within the Optical Long-Haul Networks segment.
We performed further assessments for the three months ended September 30, 2001 and the three months ended December 31, 2001 of the carrying values of intangible assets based on the intangible asset balances outstanding in each period. The conclusion of these assessments was that no additional write down of intangible assets was required.
Fair value was determined based on discounted future cash flows for the businesses that had separately distinguishable intangible asset balances and whose operations had not yet been fully integrated into Nortel Networks. The cash flow periods used were five years, the discount rate used was 20 percent, and the terminal values were estimated based upon terminal growth rates ranging from 5 to 11 percent. The assumptions supporting the estimated future cash flows, including the discount rate and estimated terminal values, reflected management’s best estimates. The discount rate was based upon our weighted average cost of capital, as adjusted for the risks associated with the operations.
Also, as part of our initiatives to streamline our business around our potential core growth areas, on June 20, 2001, we closed the operations acquired on the acquisition of EPiCON, Inc. The remaining net book value of goodwill and acquired technology related to the EPiCON transaction was written off as part of our assessment of the carrying values of intangible assets for the three months ended June 30, 2001. The closure of the EPiCON operations did not have a material impact on our business, results of operation, and financial condition.
For additional information related to these restructuring activities, see “Special charges” in note 7 to the accompanying audited consolidated financial statements and notes thereto.
Loss (gain) on sale of businesses
Loss on sale of businesses for 2001 of $112 related to a $233 write down of our Service Commerce business, which was identified for disposition, including the operations acquired on the acquisition of Architel Systems Corporation, to its net realizable value during the three months ended December 31, 2001. The write down related primarily to goodwill. Net realizable value was determined based on the anticipated proceeds on the sale of the business, which was completed on February 1, 2002. The loss was partially offset by net gains associated with both the outsourcing of certain activities as part of our continued supply chain transformation strategy that began in 1999 and the divestiture of certain non-core businesses in connection with our work plan to streamline our business around core markets.
Gain on sale of businesses for 2000 of $174 related primarily to the divestiture of certain manufacturing operations and tangible and intangible assets in connection with our operations strategy.
Gain on sale of businesses for 1999 of $131 related primarily to the divestiture of certain of our manufacturing and repair operations and assets.
36
Other income (expense) — net
For 2001, other expense - net of $351 primarily related to the write down of certain minority investments. This write down resulted from our review of our investment portfolio, which occurs on a quarterly basis, during the third quarter of 2001, and was due to a change in our strategic focus relative to certain minority investments, as well as an other than temporary decline in carrying values caused by a continued significant downturn in both the industry and economic environment. Public company investments were generally written down to current market value, resulting in mark-to-market adjustments previously recorded in accumulated other comprehensive income being recorded against earnings. Private company investments were written down to the estimated current market value by applying a telecommunications market average adjustment factor calculated using the declines of a representative group of public companies.
For 2000, other income - net of $809 primarily related to a $513 pre-tax ($344 after-tax) gain from the sale of a portion of our share ownership in Entrust, Inc. (formerly Entrust Technologies, Inc.) in the first quarter of 2000, and a $169 pre-tax ($116 after-tax) gain due to a reduction in our investment in Entrust from 33.5 percent to 27.0 percent primarily as a result of Entrust’s issuance of common shares in connection with its acquisition of enCommerce, Inc. in the third quarter of 2000.
For 1999, other income - net of $209 primarily related to sales of certain investments.
Interest expense
The increase in interest expense of $142 in 2001, compared to 2000, was primarily related to additional interest expense due to new debt offerings in the year, and an increase in the amount and cost of borrowings under the commercial paper program during the first and second quarters of 2001 (See “Liquidity and capital resources” for additional information).
Interest expense was up slightly in 2000, compared to 1999, as a result of consistent debt levels during the two periods.
Income tax benefit (provision)
Our effective tax benefit (provision) rate fluctuates from year to year primarily as a result of the impact of non-tax deductible goodwill amortization and in-process research and development expense, stock option compensation, goodwill write downs and certain non-tax deductible restructuring charges. Excluding these impacts, our effective tax benefit (provision) rate for the years ended December 31, 2001, 2000, and 1999 was a benefit rate of 31 percent, a provision rate of 32 percent, and a provision rate of 34 percent, respectively. The change in rates for 2001 compared to 2000, and 2000 compared to 1999, primarily reflected changes in geographic pre-tax earnings (loss) mix, as well as the impact of valuation allowances established on the 2001 losses.
Net loss from continuing operations
As a result principally of the foregoing factors, net loss from continuing operations increased by $21,312 in 2001 compared to 2000, and increased by $2,738 in 2000 compared to 1999. We reported a net loss in the current year from continuing operations of $24,307, or $7.62 per common share, compared to a net loss from continuing operations of $2,995, or $1.01 per common share, for 2000, and a net loss from continuing operations of $257, or $0.10 per common share, for 1999.
Results of operations - discontinued operations
We recorded a net loss of $3,010 from discontinued operations (net of tax) during the year ended December 31, 2001, comprised of a $442 loss from operations (net of tax) and a $2,568 loss on disposal of operations (net of tax) ($3,172 pre-tax). The estimated loss on disposal of the access solutions operations (pre-tax) reflects the costs directly associated with discontinuing operations and the net loss of the access solutions operations during the phase-out period. Major components of the loss included future contractual obligations and estimated liabilities of $1,104 (pre-tax); the write-off of goodwill associated with the acquisitions of Sonoma Systems and Promatory Communications, Inc. of $755 (pre-tax); provisions for
37
both short-term and long-term receivables of $601 (pre-tax); and a provision for inventories of $379 (pre-tax). We did not revise our estimate of the net loss on disposal, recorded in the three months ended June 30, 2001, during the second half of 2001. Revenues for access solutions operations were $996 for the year ended December 31, 2001. The access solutions operations also used net cash of $701 during 2001 (See “Discontinued operations” in note 4 to the accompanying audited consolidated financial statements and notes thereto for additional information).
Critical accounting policies
Revenue recognition
Nortel Networks revenue recognition accounting policies are determined in accordance with the standards and guidance provided by United States generally accepted accounting principles. Our revenue streams are the result of a wide range of activities, from custom design and installation over a long period of time to “out of the box solutions,” with numerous variations in between. Our solutions also cover a broad range of technologies and are offered on a global basis. As a result, if we are selling products based on more established technologies, our revenue recognition policies can differ between regions depending on the level of knowledgeable installers within the region and whether we are installing the equipment. Newer technologies within a segment may also have different revenue recognition policies, depending on, among other factors, the specific performance and acceptance criteria within the applicable contract. Therefore, management must use judgment in determining how to apply the current standards and interpretations, not only based on solution, but also within solutions based on technology development and geographic region. As a result, Nortel Networks revenues may fluctuate from period to period based on the mix of solutions sold and in which geographic region they are sold. We refer you to note 2(d) of the accompanying audited consolidated financial statements and notes thereto for a detailed discussion of our revenue recognition policies related to our material revenue streams.
Provisions for long-term receivables
In establishing the appropriate provisions for long-term receivables, management must regularly review the financial stability of individual customers. This analysis involves a judgment of a counterparty’s ability to meet and sustain its financial commitments, and takes into account a counterparty’s current and projected financial condition and the positive or negative effects of the current and projected industry outlook, as well as that of the economy in general. When all of these factors are fully considered, a determination is made as to the probability of default. An appropriate provision is then made, taking into account the severity of loss likely on the receivable balance in recovery. A misinterpretation or misunderstanding of these conditions, or other failure to estimate the counterparty’s projected financial condition, or uncertainty in the future outlook of our industry or the economy could result in bad debts in excess of the provisions determined to be appropriate as at the balance sheet date.
Provisions for inventory
In establishing the appropriate provisions for inventory, management must make estimates about the future customer demand for our products, taking into account both general economic conditions and growth prospects within our customers’ ultimate marketplace, the market acceptance of our current and pending products. These judgments must be made in the context of our customers’ shifting technology needs and changes in the geographic mix of our customers. A misinterpretation or misunderstanding of these conditions or uncertainty in the future outlook of our industry or the economy, or other failure to estimate correctly, could result in inventory losses in excess of the provisions determined to be appropriate as at the balance sheet date.
Tax asset valuation
In establishing the appropriate valuation reserve for tax loss carry-forwards, which have arisen primarily in 2001, all available evidence, both positive and negative must be considered. Historical information of profitability is supplemented by all currently available information about future years. In our current environment, due to the lack of visibility, there is a greater degree of uncertainty that the level of future profitability used to determine the appropriate valuation reserve would be achieved. As a result, additional valuation reserves may be required.
38
Liquidity and capital resources
Cash flows
Cash and cash equivalents, or cash, were $3,513 at December 31, 2001, an increase of $1,869 (including net cash used by the access solutions operations of $701) from December 31, 2000.
Cash flows from operating activities were $425 in 2001. Cash flows from operating activities resulted from changes in operating assets and liabilities, almost entirely offset by a net loss of $7,366, adjusted for non-cash items. The decline in accounts receivable was primarily the result of declining revenues in 2001, in addition to an increase in our provisions. The decline in inventories was due to our efforts in light of the economic environment to reduce inventory levels by reducing our manufacturing capacity, and increased provisions. The increase in accounts payable and accrued liabilities was due to our special charges provisions as at December 31, 2001. Partially offsetting these impacts was an increase in income taxes recoverable. As a result of the losses incurred during 2001, we are amending prior year tax returns to recover taxes previously paid.
Cash flows used in investing activities were $801 in 2001. The use of cash was primarily due to expenditures for plant and equipment and a net increase in long-term receivables during the period, partially offset by proceeds on sale of investments and businesses. The expenditures of $1,300 for plant and equipment largely reflected purchases related to general infrastructure, incurred primarily during the first half of 2001 and due to commitments made during the last half of 2000. We are currently focusing expenditures for plant and equipment on our core businesses. The previously announced investment plan to expand optical components and systems production capacity and capability was discontinued during the second quarter of 2001 as a result of the business environment. The net increase in long-term receivables during the period was approximately $234, primarily attributable to increased funding of customer financings in the first half of 2001, partially offset by increased provisions as a result of the economic environment. Proceeds on sale of businesses and investments of $604 resulted primarily from the outsourcing of manufacturing activities and the divestiture of certain non-core businesses in connection with our work plan to streamline our business around core markets.
Cash flows generated from financing activities were $2,956 in 2001. Cash flows from financing activities primarily resulted from our private offering of $1,800 of 4.25 percent convertible senior notes completed on August 15, 2001, and Nortel Networks Limited’s debt offering of $1,500 of 6.125 percent notes completed on February 8, 2001.
On August 15, 2001, we completed a private offering of $1,800 of 4.25 percent convertible senior notes, due on September 1, 2008. These notes pay interest on a semi-annual basis on March 1 and September 1, which began on March 1, 2002. These notes are convertible at any time by holders into common shares of Nortel Networks Corporation at an initial conversion price of ten dollars per common share (subject to adjustment upon the occurrence of certain events). Nortel Networks Limited is the guarantor of the notes. Nortel Networks Corporation may redeem some or all of these notes in cash at any time on or after September 7, 2004 at a redemption price of between 100% and 102.125% of the principal amount of these notes depending on the redemption date, plus accrued and unpaid interest and additional interest, if any, to the date of the redemption. These notes are also redeemable upon the occurrence of certain events at a redemption price equal to the principal amount thereof plus accrued and unpaid interest.
On February 8, 2001, Nortel Networks Limited completed an offering of $1,500 of 6.125 percent notes due on February 15, 2006. These notes pay interest on a semi-annual basis on February 15 and August 15, which began on August 15, 2001. These notes are redeemable, at any time at Nortel Networks Limited’s option, at a redemption price equal to the principal amount thereof plus accrued and unpaid interest and a make-whole premium.
Uses of liquidity
Our cash requirements through the end of 2002 are primarily to fund operations, research and development, capital expenditures, workforce reduction and restructuring activities, debt service, and customer financings. The following provides additional information related to our uses of liquidity.
39
The remaining cash outlays of $400 related to workforce reduction initiatives are expected to be substantially completed by the end of 2002, and the remaining cash payments of $773 related to contract settlement and lease costs are expected to be substantially completed by the end of 2004. An additional charge will be incurred in the first quarter of 2002, and further charges may be incurred in the second quarter of 2002, related to remaining announced workforce reductions and related charges. See “Special charges” for additional information.
Common share dividends
On June 15, 2001, Nortel Networks Corporation announced that its Board of Directors had decided to discontinue future common share dividends after payment on June 29, 2001 of the $0.01875 per common share dividend, which will improve our cash flow by approximately $60 per quarter.
Cash obligations
The following table provides information related to our contractual cash obligations under various financial and commercial agreements:
Commitments and guarantees
We enter into bid and performance bonds related to various contracts, which generally have terms of less than two years. Potential payments due under these bonds are related to performance under the applicable contract. We have not historically had to make material payments under these types of bonds and we currently do not anticipate that we will be required to make payments under the current bonds. The following table provides information related to potential commercial commitments.
We have also entered into supply contracts with customers for products and services, which in some cases involve new technologies currently being developed, or which we have not yet commercially deployed, or which require us to build and operate networks on a turnkey basis. We have also entered into network outsourcing contracts with customers to operate their networks. Some of these supply and network outsourcing contracts contain delivery and installation timetables, performance criteria and other contractual obligations which, if not met, could result in our having to pay substantial penalties or liquidated damages, the termination of the related supply or network outsourcing contract, and/or the reduction of
40
shared revenues under a turnkey arrangement, in certain circumstances. As is customary for the telecommunications industry, these supply and networking outsourcing contracts are highly customized to address each customer’s particular needs and concerns and, therefore, the nature of the events triggering, as well as the actual amounts of the penalties, vary greatly and are based on a variety of complex, interrelated factors, and may vary significantly in amount over the life of the contract. We have not experienced material penalty payments in any recent reporting period.
Further, certain of our supply arrangements with our contract manufacturers were negotiated prior to the current industry and economic downturn and, depending upon the extent and duration of this downturn, the terms of these arrangements may not be achievable. To the extent that we fail to meet any of these arrangements, and if we are unable to successfully renegotiate the applicable arrangement, we may be obligated to indemnify the contract manufacturer for certain direct costs attributable to our failure to so perform. The actual amount of any such indemnification, which could be substantial, would be based on a variety of complex, inter-related factors. The failure to reach a satisfactory resolution of any such matter could have a material adverse effect on our business, results of operations, financial condition, and supply relationships.
Customer financing
The following table provides information related to customer financing commitments as at the years ended December 31:
Customer financing arrangements may include financing in connection with the sale of our products and services, as well as funding for certain non-product and service costs associated with network installation and integration of our products and services, and financing for working capital purposes and equity financing.
As a result of the competitive environment during 1999 and 2000, we provided significant amounts of medium-term and long-term customer financing, resulting in a significant increase in both undrawn commitments for customer financing and drawn and outstanding balances. During this period, we continued to fund our customer financing commitments and were also able to regularly place both undrawn commitments and drawn and outstanding balances with third-party lenders. However, our ability to place customer financing with third-party lenders was significantly reduced during 2001 due to, among other factors, recent economic downturns in various countries, capital market conditions, adverse changes in the credit ratings of our customers and ourselves, and reduced demand for telecommunications financings in capital and bank markets. During the same period, several customers failed to meet the borrowing conditions set forth in their customer financing arrangements or reduced their commitments to purchase our products and services and, as a result, our commitments to provide customer financing were reduced or withdrawn. This resulted in a decline in our undrawn commitments throughout 2001. During 2001, certain of our customers, including competitive local exchange carriers, filed for bankruptcy or experienced financial difficulties. As a result of our reviews of our customer financing receivables during 2001, we increased our customer financing provisions to reflect our expectation that certain customers will be unable to meet their repayment obligations to us in the future as a result of the current market conditions. Primarily as a result of these increased provisions recorded during the year, the drawn and outstanding customer financing balance decreased significantly in 2001, compared to 2000.
We continue to regularly assess the levels of our customer financing provisions based on a loan-by-loan review to evaluate whether they reflect current market conditions, as well as the ability of our customers to meet their repayment obligations. We also continue to restructure financings to minimize losses and reduce undrawn commitments where possible. In addition to being highly selective in providing customer financing, we have various programs in place to monitor and
41
mitigate customer credit risk, including performance milestones and other conditions of funding. Management is focused on the strategic use of our limited customer financing capacity, on revolving that capacity as quickly and efficiently as possible, and on managing the absolute dollar amount of our customer financing exposure.
We currently have customer financing commitments and balances outstanding in connection with the turnkey construction of new networks, particularly third generation, or 3G, wireless networks, and we may commit to provide additional funding in the future if such financings are strategic to our core business activities. We have traditionally been able to place a large amount of our customer financing obligations with third-party lenders. However, we are currently directly supporting more of such commitments and outstanding balances of such customer financings due to capital market conditions and the financial difficulties experienced by some customers. We anticipate that we will be required to directly support a significantly greater amount of future customer financings compared to our past experience. We will continue to seek to arrange for third-party lenders to assume our customer financing obligations and to fund customer financings from working capital and conventional sources of external financing in the normal course. However, our customer financing commitments and balances outstanding may increase substantially as a result of us continuing to hold such customer financings. We may also enter into additional customer financing arrangements, resulting in further customer financing commitments and balances outstanding.
See “Forward-looking statements” for additional factors that may impact our customer financing arrangements.
Discontinued operations
At December 31, 2001, the remaining accruals totalled $366 and were related to certain future contractual obligations and estimated liabilities of the discontinued access solutions operations, and estimated operating losses during the planned period of disposition. Such accruals are expected to be drawn down by cash payments, the impact of which is expected to be partially offset by cash inflows generated from the sale of certain assets over the planned period of disposition.
For additional information related to discontinued operations, see “Discontinued operations” in note 4 to the accompanying audited consolidated financial statements and notes thereto.
Sources of liquidity
Following the February 8, 2001 offering of $1,500 of 6.125 percent notes by Nortel Networks Limited, Nortel Networks Limited and its financing subsidiary have remaining capacity to issue from time to time up to an aggregate of $1,000 of debt securities and warrants to purchase debt securities, pursuant to a shelf registration statement filed with the United States Securities and Exchange Commission. Refer to the discussion below regarding our debt ratings and also see “Forward-looking statements” for factors that may affect this program.
Nortel Networks Limited also filed in each of the provinces of Canada a short form prospectus under the Canadian shelf prospectus program qualifying it to issue up to $500 (Canadian) of debt securities and warrants to purchase debt securities. This program expired on February 23, 2002.
On June 14, 2001, Nortel Networks Limited and its subsidiary, Nortel Networks Inc., entered into 364-day credit agreements with certain banks to permit borrowings in an aggregate amount up to $2,000, with a one-year term out option to convert outstanding amounts under the credit agreements into term loans on the termination date of the credit agreements. Effective December 20, 2001, Nortel Networks Limited and Nortel Networks Inc. amended their June 14, 2001 $2,000 364-day syndicated credit agreements. These amendments reduced the size of the committed facilities to $1,575 and extended the term of the credit agreements to December 13, 2002, with a one-year term out option to convert outstanding amounts under the credit agreements into term loans on December 13, 2002.
The credit agreements contain financial covenants that require (i) the maintenance of a minimum consolidated tangible net worth at the consolidated Nortel Networks Limited level, and (ii) the achievement of certain minimum consolidated earnings before interest, taxes, depreciation and amortization, or EBITDA, thresholds at the Nortel Networks level beginning in the first quarter of 2002. The minimum consolidated tangible net worth of Nortel Networks Limited required is $1,880. The consolidated EBITDA covenant requires that we achieve a cumulative EBITDA of negative $500 or
42
better for the three months ended March 31, 2002. In addition, there are minimum EBITDA covenants in place for the remainder of fiscal year 2002 and the first three quarters of 2003, tested in quarterly increments during the period. Compliance with this covenant will require EBITDA improvements during the fiscal year 2002, and further improvements in the year thereafter. Certain business restructuring charges and other one-time charges and gains will be excluded from the calculation of EBITDA. In addition, these credit agreements contain covenants restricting additional debt, the payment of dividends, corporate events, liens, sale and leasebacks, and investments, among others. Payments of dividends on the outstanding preferred shares of Nortel Networks Limited is permitted provided that compliance with certain covenants of the credit agreements is maintained. These credit agreements also provide for the granting of security, which may include a pledge of shares and/or a guarantee, over substantially all of Nortel Networks Limited’s assets and those of most of its United States and Canadian subsidiaries, and also provide for either a pledge of shares or a guarantee by certain of Nortel Networks Limited’s other subsidiaries. The security will be granted in the event that one of Nortel Networks Limited’s United States senior unsecured long-term debt ratings falls below investment grade, defined as either Baa3 or BBB-, as determined by Moody’s Investors Services, Inc. or Standard & Poor’s Ratings Service, respectively. The security would be released when both of these debt ratings return to Baa2 (with a stable outlook) and BBB (with a stable outlook), as determined by Moody’s and Standard & Poor’s, respectively. In the event that such security is in fact granted as a result of such rating downgrade, certain other financings and debt obligations, including certain future financings and obligations, will also be secured to the extent required by the terms and conditions of such financings and obligations during the time that the security arrangements under the credit agreements are in effect.
On April 12, 2000, Nortel Networks Limited and Nortel Networks Inc. entered into five-year and 364-day syndicated credit agreements, which permit borrowings in an aggregate amount of up to $2,000. On April 11, 2001, Nortel Networks Limited and Nortel Networks Inc. extended and increased the April 12, 2000, 364-day syndicated credit agreements to permit borrowings in an aggregate amount of up to $1,750 from $1,250, with a one-year term out option to convert outstanding amounts under the 364-day syndicated credit agreements into term loans on the termination date of the credit agreements. As a result, total borrowings permitted under these syndicated five-year and 364-day credit agreements are $2,500. We had not drawn on these syndicated credit agreements as at December 31, 2001. These agreements can be used for borrowings for general corporate purposes, and to support borrowings under our commercial paper program. Borrowings related to the commercial paper program have been reduced to nil at December 31, 2001 from prior levels during the year, as a result of the commercial paper market currently being effectively closed to us due to our current debt ratings. We anticipate that any amendment or extension of these credit facilities will likely require our agreement to covenants similar to the amended June 14, 2001 credit agreements due to our current debt rating.
At December 31, 2001 we were in compliance with the covenants of our credit agreements and had not drawn on any of the credit agreements. In addition, Nortel Networks Limited’s long-term debt ratings were within investment grade as determined by both Moody’s and Standard & Poor’s. Refer to the discussion below regarding our debt ratings and see “Forward-looking statements” for factors that may affect our ability to comply with covenants and conditions in our credit agreements.
The total debt to total capitalization ratio of Nortel Networks was 47 percent at December 31, 2001, compared to 6 percent at December 31, 2000. The increase in the total debt to total capitalization ratio at December 31, 2001, compared to December 31, 2000, was due to the reduction in retained earnings as a result of the net losses for 2001, and the increase in total debt primarily due to the issuance of $1,800 of 4.25 percent convertible senior notes on August 15, 2001 and $1,500 of 6.125 percent notes on February 8, 2001.
Subsequent to the second quarter of 2001, we completed or announced several transactions to divest portions of our business, primarily related to the continuing transformation of our supply chain from a vertically integrated manufacturing model to a virtually integrated model, and in conjunction with our work plan to divest non-core businesses. Net cash proceeds from these transactions are expected to be approximately $700, of which approximately $500 has been received as at December 31, 2001 and $200 is expected to be realized during the next several quarters. Transactions completed during 2001 included the following:
43
Credit ratings
Our credit ratings as at December 31, 2001 were as follows:
Despite the lowered ratings, our ratings from Standard & Poor’s and Moody’s remain within investment grade levels. The ratings remain on review for possible future downgrade (Moody’s) and negative outlook (Standard & Poor’s). There can be no assurance that our credit ratings will not be lowered further, to below investment grade, or that such ratings agencies will not issue adverse commentaries, resulting in higher financing costs under our credit facilities and for other financings generally, and reduced access to the capital markets or our credit agreements. In addition, if our credit ratings are reduced, we will be required to deliver the prescribed security to the lenders in order to access the $1,575 credit facilities under the December 20, 2001 amended credit agreements. Our credit ratings also affect our ability, and the cost, to securitize receivables. See “Forward-looking statements” for effects of changes in respect of our debt ratings.
During 2001, we took actions to strengthen our cash and liquidity positions and as of December 31, 2001, our primary source of liquidity was our current cash and cash equivalents. We believe this cash, together with cash flows from operations, will be sufficient to meet our working capital, capital expenditure, and investment requirements through the end of fiscal 2002, with potential fundings under our credit facilities to address cash flow fluctuations within quarters. If our revenues and cash flows are materially lower than we expect, we may be required to further reduce capital expenditures and investments in order to meet our cash requirements. We may seek additional funds from liquidity-generating transactions and other conventional sources of external financing (which may include a variety of debt, convertible debt, and/or equity financings). We cannot provide any assurance that our net cash requirements will be as we currently expect, that we will continue to have access to our credit facilities when and as needed, or that liquidity-generating transactions or financings will be available to us on acceptable terms or at all. See “Forward-looking statements” for factors that may affect our revenues, cash flows and debt levels.
44
Market risk
Market risk represents the risk of loss that may impact our consolidated financial statements through adverse changes in financial market prices and rates. Our market risk exposure results primarily from fluctuations in interest rates and foreign exchange rates. To manage the risk from these fluctuations, we enter into various derivative-hedging transactions that we have authorized under our policies and procedures. We maintain risk management control systems to monitor market risks and counter-party risks. These systems rely on analytical techniques including both sensitivity analysis and value-at-risk estimations. We do not hold or issue financial instruments for trading purposes.
For a discussion of our accounting policies for derivative financial instruments, see “Significant accounting policies” in note 2(m) to the accompanying audited consolidated financial statements and notes thereto. Additional disclosure of our financial instruments is included in “Financial instruments and hedging activities” in note 16 to the accompanying audited consolidated financial statements and notes thereto.
We manage foreign exchange exposures using forward and option contracts to hedge firm sale and purchase commitments. Our most significant foreign exchange exposures are in the Canadian dollar, the United Kingdom pound, and the Euro. We enter into United States to Canadian dollar forward and option contracts intended to hedge the United States to Canadian dollar exposure on future revenue and expenditure streams. We recognize the gains and losses on these contracts in income when the hedged transaction occurs.
We continue to expand our business globally and, as such, an increasing proportion of our business will be denominated in currencies other than United States dollars. As a result, fluctuations in foreign currencies may have a material impact on our business, results of operations, and financial condition. We endeavour to minimize the impact of such currency fluctuations through our ongoing commercial practices and by attempting to hedge our exposures to major currencies. In attempting to manage this foreign exchange risk, we identify 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 our significant foreign currencies. Our significant currency flows for the year ended December 31, 2001 were in United States dollars, Canadian dollars, United Kingdom pounds, and the Euro. For 2001, the net impact of foreign exchange fluctuations was a gain of $2, compared to a gain of $10 for 2000 and a loss of $93 for 1999. Given the devaluation of the Euro in 2001, and our exposure to other international markets, we continuously monitor all of our foreign currency exposures. We cannot predict whether we will incur foreign exchange losses in the future; however, if significant foreign exchange losses are experienced, they could have a material adverse effect on our business, results of operations, and financial condition.
We manage interest rate exposures using a diversified portfolio of fixed and floating rate instruments denominated in several major currencies. We manage these exposures using interest rate swaps, which reduce our cost of financing and the fluctuations in the aggregate interest expense. We book net settlements on these swap instruments as adjustments to interest expense.
We use sensitivity analysis to measure our foreign currency risk by computing the potential decrease in cash flows that may result from adverse changes in foreign exchange rates. The balances are segregated by source currency, and a hypothetical unfavourable variance in foreign exchange rates of 10 percent is applied to each net source currency position using year-end rates, to determine the potential decrease in cash flows over the next year. The sensitivity analysis includes all foreign currency-denominated cash, short-term and long-term debt, and derivative instruments that will impact cash flows over the next year that are held at December 31, 2001 and 2000, respectively. The underlying cash flows that relate to the hedged firm commitments are not included in the analysis. The analysis is performed at the reporting date and assumes no future changes in the balances or timing of cash flows from the year-end position. Further, the model assumes no correlation in the movement of foreign exchange rates. As at December 31, 2001 and 2000, based on a one-year time horizon, a 10 percent adverse change in the exchange rates would result in a potential decrease in after-tax cash flows of approximately $91 and $86, respectively. This potential decrease would result primarily from our exposure to the Canadian dollar, the United Kingdom pound, and the Euro.
45
We also use sensitivity analysis to measure our interest rate risk. As at December 31, 2001, a 100 basis point adverse change in interest rates would not have a material effect on our business, results of operations, and financial condition.
Legal proceedings
In connection with the January 28, 2000 acquisition of Qtera, Qtera and two of its employees were named as defendants in a lawsuit filed by Siemens ICN in the 15th Judicial Circuit for Palm Beach County, Florida. The lawsuit alleged various claims, including purported misappropriation of trade secrets. This dispute has been resolved to the satisfaction of the parties and without material adverse effect to Nortel Networks.
Subsequent to the February 15, 2001 announcement in which Nortel Networks Corporation provided revised guidance for financial performance for the 2001 fiscal year and the first quarter of 2001, Nortel Networks Corporation and certain of its then current officers and directors were named as defendants in more than twenty-five purported class action lawsuits. These lawsuits, which have been served through September 24, 2001, in the United States District Courts for the Eastern District of New York, for the Southern District of New York and for the District of New Jersey, and in the provinces of Ontario, Quebec, and British Columbia in Canada, on behalf of shareholders who acquired Nortel Networks Corporation’s securities as early as October 24, 2000 and as late as February 15, 2001, allege, among other things, violations of United States federal and Canadian provincial securities laws. Securities regulatory authorities in Canada and the United States are also reviewing these matters. A class action lawsuit was also filed in the United States District Court for the Southern District of New York on behalf of shareholders who acquired the securities of JDS Uniphase Corporation between January 18, 2001 and February 15, 2001, alleging violations of the same United States federal securities laws as the other lawsuits. On May 11, 2001, we filed motions to dismiss and/or stay in connection with the three proceedings in Quebec primarily based on the factual allegations lacking substantial connection to Quebec and the inclusion of shareholders resident in Quebec in the class claimed in the Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec announced their decision on November 6, 2001 to discontinue their proceedings and obtained court approval for such discontinuances on January 17, 2002. The motion to dismiss and/or stay the third proceeding was heard on November 6, 2001 and the court deferred any determination on the motion to the judge who will hear the application for authorization to commence a class proceeding. On December 6, 2001, we filed a motion seeking leave to appeal that decision. On October 16, 2001, an order in the Southern District of New York was filed consolidating twenty-five of the related United States class action lawsuits into a single case, appointing class plaintiffs and counsel for such plaintiffs. The plaintiffs served a consolidated amended complaint on January 18, 2002. On December 17, 2001, the defendants in the British Columbia action served notice of a motion requesting the court to decline jurisdiction and to stay all proceedings on the ground that British Columbia is an inappropriate forum. In addition, a purported class action lawsuit was filed in the United States District Court for the Middle District of Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel Networks Long-Term Investment Plan at any time during the period of March 7, 2000 through the filing date and who made or maintained plan investments in Nortel Networks Corporation’s common shares, under the Employee Retirement Income Security Act for plan-wide relief and alleging, among other things, material misrepresentations and omissions to induce plan participants to continue to invest in and maintain investments in Nortel Networks Corporation’s common shares in the plan.
On February 12, 2001, Nortel Networks Inc., an indirect subsidiary, was served with a consolidated amended class action complaint that purported to add Nortel Networks Corporation as a defendant to a lawsuit commenced in July 2000 against Entrust and two of its then current officers in the United States District Court for the Eastern District of Texas (Marshall Division), or the District Court. This complaint alleges that Nortel Networks Corporation, Entrust, and two officers of Entrust violated the Securities Exchange Act of 1934 with respect to certain statements made by Entrust. Nortel Networks Corporation is alleged to be a controlling person of Entrust. On April 6, 2001, we filed a motion to dismiss the first complaint. On July 31, 2001, the first complaint was dismissed without prejudice. On August 31, 2001, the plaintiffs filed a second amended class action complaint against the same defendants asserting claims substantively similar to those in the first complaint. On September 21, 2001, we filed a motion to dismiss this second complaint. The motion is currently under consideration by the District Court.
On March 4, 1997, Bay Networks, Inc., a company acquired on August 31, 1998, announced that shareholders had filed two separate lawsuits in the United States District Court for the Northern District of California, or the Federal Court, and the California Superior Court, County of Santa Clara, or the California Court, against Bay Networks and ten of Bay Networks’ then current and former officers and directors, purportedly on behalf of a class of shareholders who purchased Bay
46
Networks’ common shares during the period of May 1, 1995 through October 14, 1996. On August 17, 2000, the Federal Court granted the defendants’ motion to dismiss the federal complaint and on September 8, 2000, a notice of appeal of that order and judgment was filed by the plaintiffs. On August 1, 2001, the United States Court of Appeals for the Ninth Circuit, or the Ninth Circuit, denied the plaintiffs’ appeal. On April 18, 1997, a second lawsuit was filed in the California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks’ common shares pursuant to the registration statement and prospectus that became effective on November 15, 1995. The two actions in the California Court were consolidated in April 1998; however, the California Court denied the plaintiffs’ motion for class certification. In January 2000, the California Court of Appeal rejected the plaintiffs’ appeal of the decision. A petition for review was filed with the California Supreme Court by the plaintiffs and was denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay Networks during the relevant periods, filed a motion for intervention in the California Court seeking to become the representatives of a class of shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their complaint-in-intervention on an individual and purported class representative basis alleging misrepresentations made in connection with the purchase and sale of securities of Bay Networks in violation of California statutory and common law. On June 18, 2001, the defendants removed the consolidated state court actions to the Federal Court. On September 19, 2001, the defendants’ motion to dismiss the complaint was rejected and the plaintiffs’ motion to remand the case to the California Court was granted. The defendants filed an appeal in the Ninth Circuit on October 2, 2001 with respect to the decisions in such motions, and the Ninth Circuit dismissed the appeal on December 26, 2001.
In each of the matters described above, plaintiffs are seeking an unspecified amount of money damages.
We are also a defendant in various other suits, claims, proceedings and investigations that arise in the normal course of business.
We are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact of the above matters which seek damages of material or indeterminate amounts, and therefore cannot determine whether these actions, suits, claims, proceedings and investigations will, individually or collectively, have a material adverse effect on our business, results of operations, and financial condition. We and any of our named directors and officers intend to vigorously defend these actions, suits, claims, proceedings and investigations.
Environmental matters
For a discussion of Environmental matters, see “Contingencies” in note 19 to the accompanying audited consolidated financial statements and notes thereto.
Employee defined benefit plans
We maintain various defined benefit plans for our employees in North America and the United Kingdom. As a result of the worldwide economic downturn during 2001 and the September 11, 2001 terrorist attacks in the United States, the fair market value of the defined benefit plan assets declined significantly from the comparable period in the prior year. While the fair market value of the plan assets has appreciated since September 30, 2001 (the annual measurement date for pension expense purposes), the plan assets remain significantly devalued compared to the previous measurement year. As a result, the three largest plans have changed from a fully funded position to an unfunded position for accounting purposes. However, based on our latest actuarial valuations, and utilizing long-term assumptions consistent with those in prior years, our cash funding requirements for 2002 are expected to be moderate and substantially consistent with 2001. Plan assets are comprised primarily of common stocks, bonds, debentures, secured mortgages, and property. Included in plan assets are common shares of Nortel Networks Corporation with an aggregate market value of $23 in 2001 ($66 in 2000). See note 13 to the accompanying audited consolidated financial statements and notes thereto for additional details.
Forward-looking statements
Certain information and statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report, including statements containing words such as “could,” “expects,” “may,” “anticipates,” “believes,” “intends,” “estimates,” “plans,” and similar expressions, are forward-looking statements. These address our business, results of operations, and financial condition, and include statements based on current
47
expectations, estimates, forecasts, and projections about the operating environment, economies and markets in which we operate and our beliefs and assumptions regarding such operating environment, economies and markets. In addition, we or others on our behalf may make other written or oral statements which constitute forward-looking statements. This information and such statements are subject to important risks, uncertainties, and assumptions, which are difficult to predict. The results or events predicted in these statements may differ materially from actual results or events. Some of the factors which could cause results or events to differ from current expectations include, but are not limited to, the factors set forth below. Except as otherwise required by applicable securities laws, we disclaim any intention or obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
We have restructured our business and recorded a write down of intangible assets in the past to respond to industry and market conditions. The assumptions underlying our restructuring efforts and intangible assets write down may prove to be inaccurate and we may have to restructure our business or incur additional intangible asset write downs again in the future.
In response to changes in industry and market conditions, we have restructured our business in the past, are currently restructuring our business, and may again restructure our business in the future to achieve certain cost savings and to strategically realign our resources. We have based our work plan pertaining to the restructuring on certain assumptions regarding the cost structure of our business and the nature and severity of the current industry adjustment which may not prove to be accurate.
While restructuring, we have assessed, and will continue to assess, whether we should dispose of or otherwise exit businesses or further reduce our workforce, as well as review the recoverability of our tangible and intangible assets associated with those businesses. Any decision to further limit investment or to dispose of or otherwise exit businesses may result in the recording of additional charges, such as workforce reduction costs, facilities reduction costs, asset write downs, and contractual settlements. Additionally, estimates and assumptions used in asset valuations are subject to uncertainties, as are accounting estimates with respect to the useful life and ultimate recoverability of our carrying basis of assets, including goodwill and other intangible assets. As a result, future market conditions may result in further charges for the write down of tangible and intangible assets.
We may not be able to successfully implement the initiatives we have undertaken in restructuring our business and, even if successfully implemented, these initiatives may not be sufficient to meet the changes in industry and market conditions and to achieve future profitability.
We must successfully implement our work plan if we are to adjust our cost structure to reflect current and expected future economic conditions, market demands and revenues, and to achieve future profitability. We must also manage the potentially higher growth areas of our business, as well as the non-core areas of our business, effectively in light of current and expected future market demands and trends.
Under our work plan, we have also implemented a number of initiatives, including exiting businesses and writing down our tangible and intangible assets, to streamline our business, and to focus our investments on delivering what we believe to be the key next-generation networking solutions. However, our work plan, including workforce reductions, may not be sufficient to meet the changes in industry and market conditions, and such conditions may continue to deteriorate or last longer than we expect. In addition, we may not be able to successfully implement our work plan and may be required to refine, expand or extend our work plan. Furthermore, our workforce reductions may impair our ability to realize our current or future business objectives. Lastly, costs actually incurred in connection with restructuring actions may be higher than the estimated costs of such actions and/or may not lead to the anticipated cost savings. As a result, our restructuring efforts may not result in our return to profitability.
Our operating results have historically been subject to yearly and quarterly fluctuations and are expected to continue to fluctuate.
Our operating results have historically been and are expected to continue to be subject to quarterly and yearly fluctuations as a result of a number of factors. These factors include:
48
Significant fluctuations in our operating results could contribute to volatility in the market price of Nortel Networks Corporation’s common shares.
Our gross margins may be negatively affected, which in turn would negatively affect our operating results and could contribute to volatility in the market price of Nortel Networks Corporation’s common shares.
Our gross margins may be negatively affected as a result of a number of factors, including:
49
Lower than expected gross margins would negatively affect our operating results and could contribute to volatility in the market price of Nortel Networks Corporation’s common shares.
Economic conditions in the United States, Canada, and globally, affecting the telecommunications industry, as well other trends and factors affecting the telecommunications industry, are beyond our control and may result in reduced demand and pricing pressure on our products.
There are trends and factors affecting the telecommunications industry, which are beyond our control and may affect our operations. Such trends and factors include:
Economic conditions affecting the telecommunications industry, which affect market conditions in the telecommunications and networking industry, in the United States, Canada and globally, affect our business. Reduced capital spending and/or negative economic conditions in the United States, Canada, Europe, Asia, Latin America and/or other areas of the world could result in reduced demand for or pricing pressure on our products.
We may not be able to attract or retain the specialized technical and managerial personnel necessary to achieve our business objectives.
Competition for certain key positions and specialized technical personnel in the high-technology industry is intense, despite current economic conditions. We believe that our future success depends in part on our continued ability to hire,
50
assimilate, and retain qualified personnel in a timely manner, particularly key members of senior management and in our key areas of potential growth. A key factor in attracting and retaining qualified employees is our ability to provide employees with the opportunity to participate in the potential growth of our business through programs such as stock option plans and employee investment plans. The value of these opportunities may be adversely affected by the volatility or negative performance of the market price for Nortel Networks Corporation’s common shares. We may also find it more difficult to attract or retain qualified employees because of our recent significant workforce reductions and our business performance in 2001. In addition, if we have not properly sized our workforce and retained those employees with the appropriate skills, our ability to compete effectively may be adversely affected. If we are not successful in attracting, retaining or recruiting qualified employees, including members of senior management, in the future, we may not have the necessary personnel to effectively compete in the highly dynamic, specialized and volatile industry in which we operate or to achieve our business objectives.
Future cash flow fluctuations may affect our ability to fund our working capital requirements or achieve our business objectives in a timely manner.
Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly fluctuations, depending on such factors as timing and size of capital expenditures, levels of sales, timing of deliveries and collection of receivables, inventory levels, customer payment terms, customer financing obligations, and supplier terms and conditions. Our inability to manage cash flow fluctuations resulting from such factors could have a material adverse effect on our ability to fund our working capital requirements from operating cash flows and other sources of liquidity or to achieve our business objectives in a timely manner.
Our business may be materially and adversely affected by our increased levels of debt.
In order to finance our business we have incurred, or have entered into credit facilities allowing for drawdowns of, significant levels of debt compared to historical levels, and we may need to secure additional sources of funding, including debt or convertible debt financing, in the future. A high level of debt, arduous or restrictive terms and conditions relating to accessing certain sources of funding, poor business performance or lower than expected cash inflows could have adverse consequences on the operation of our business.
In particular, certain of such credit agreements have been recently amended and now contain financial covenants that require the maintenance of a minimum consolidated tangible net worth and the achievement of certain minimum consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) thresholds. The minimum required consolidated tangible net worth of Nortel Networks Limited is $1,880. The consolidated EBITDA covenant requires that we achieve a cumulative EBITDA of negative $500 or better for the three months ended March 31, 2002. In addition, there are minimum EBITDA covenants in place for the remainder of fiscal year 2002 and the first three quarters of 2003, tested in quarterly increments during the period. Compliance with this covenant will require EBITDA improvements during the fiscal year 2002, and further improvements in the year thereafter. Certain business restructuring charges and other one-time charges and gains will be excluded from the calculation of EBITDA. These credit agreements also provide for the granting of security, which may include a pledge of shares and/or a guarantee, over substantially all of Nortel Networks Limited’s assets and those of most of its United States and Canadian subsidiaries and also provide for either a pledge of shares or a guarantee by certain of Nortel Networks Limited’s other subsidiaries. The security will be granted in the event that one of Nortel Networks Limited’s United States senior unsecured long-term debt ratings falls below investment grade, defined as Baa3 or BBB-, as determined by Moody’s Investors Services, Inc. and Standard & Poor’s Ratings Service, respectively. The security would be released when both of these debt ratings return to Baa2 (stable outlook) and BBB (stable outlook), as determined by Moody’s and Standard & Poor’s, respectively. In the event that such security is in fact granted as a result of such rating downgrade, certain other financings and debt obligations, including certain future financings and obligations, will also be secured to the extent required by the terms and conditions of such financings and obligations during the time that the security arrangements under the credit agreements are in effect.
Other effects of a high level of debt include the following:
51
Changes in respect of our public debt ratings may materially and adversely affect the availability, the cost, and the terms and conditions of our debt and asset-based financings.
Certain subsidiaries’ outstanding debt instruments are publicly rated by independent rating agencies. These public debt ratings affect our ability to raise debt, our access to the commercial paper market (which is currently effectively closed to us), and our ability to engage in asset-based financing. These public debt ratings also may negatively affect the cost to us and terms and conditions of debt and asset-based financings. Additionally, any negative developments regarding our cash flow, public debt ratings and/or our incurring significant levels of debt, or our failure to meet certain covenants under our credit agreements, could require us to grant security, lose access to, and/or cause a default under certain of our credit facilities and adversely affect further the cost and terms and conditions of our debt and asset-based financings.
Our performance may be materially and adversely affected if our expectations regarding market demand for particular products prove to be wrong.
We expect that data communications traffic will grow at a faster rate than the growth expected for voice traffic, and that the use of the Internet will continue to increase. We expect the growth of data traffic and the use of the Internet will significantly impact traditional voice networks, both wireline and wireless. We believe that this will create market discontinuities. By market discontinuities, we mean opportunities for new technologies, applications, products and services that enable the secure, rapid, and efficient transport of large volumes of data traffic over networks and allow service providers and carriers to increase revenues and improve operating results. Market discontinuities will also make traditional voice network products and services less effective as they were not designed for data traffic. We believe that these market discontinuities in turn will lead to the convergence of data and voice through upgrades of traditional voice networks to transport large volumes of data traffic or through the construction of new networks designed to transport both voice and data traffic. Either approach would require significant capital expenditures by service providers and carriers. We also believe that such developments will give rise to the demand for Internet Protocol-, or IP-, optimized networking solutions, and third generation, or 3G, wireless networks. Internet Protocol is the predominant method by which data is sent from one computer to another on the Internet — a data message is divided into smaller packets which contain both the sender’s unique IP address and the receiver’s unique IP address, and each packet is sent, potentially by different routes and as independent units, across the Internet. There is no continuing connection between the end points which are communicating versus traditional telephone communications which involve establishing a fixed circuit that is maintained for the duration of the voice or data communications call. 3G wireless networks are an evolution of communications networks from second generation wireless networks for voice and low speed data communications that are based on circuit switching — when a call is dialed, a circuit is established between the mobile handset and the third party, and the connection lasts for the duration of the call. By comparison, 3G networks allow devices to be “always on” because the networks are packet-based. We expect 3G networks to include such features as voice, high speed data communications and high bandwidth multimedia capabilities, and usability on a variety of different communications devices, such as cellular telephones and pagers, with the user having accessibility anywhere and at any time to these features.
We cannot be sure what the rate of such convergence of voice and data networks will be, due to the dynamic and rapidly evolving nature of the communications business, the technology involved and the availability of capital. Consequently, market discontinuities and the resulting demand for IP-optimized networking solutions or 3G wireless networks may not materialize. Alternatively, the pace of that development may slow. It may also be the case that the market
52
may develop in an unforeseen direction. Certain events, including the availability of new technologies or the evolution of other technologies, may occur which would affect the extent or timing of anticipated market demand, or increase demand for products based on other technologies, or reduce the demand for IP-optimized networking solutions or 3G wireless networks, which in turn may reduce purchases of our networking solutions by our customers, require increased expenditures to develop and market different technologies, or provide market opportunities for our competitors. Our performance may also be materially and adversely affected by a lack of growth in the rate of data traffic, a reduction in the use of the Internet or a reduction in the demand for IP-optimized networking solutions or 3G wireless networks in the future.
We may be materially and adversely affected by continued reductions in spending on telecommunications infrastructure by our customers.
A continued slowdown in capital spending by service providers may affect our revenues more than we currently expect. Moreover, the significant slowdown in capital spending by service providers has created uncertainty as to market demand. As a result, revenues and operating results for a particular period can be difficult to predict. In addition, there can be no certainty as to the severity or duration of the current industry adjustment. Many of our traditional customers have already begun to invest in data networking and/or are in the process of transitioning from voice-only networks to networks which include data traffic. However, as a result of the recent changes in industry and market conditions, many of our customers have reduced their capital spending on telecommunications infrastructure. Our revenues and operating results have been and are expected to continue to be materially and adversely affected by the continued reductions in capital spending on telecommunications infrastructure by our customers.
We have made, and may continue to make, strategic acquisitions in order to enhance the expansion of our business. If we are not successful in operating or integrating these acquisitions, our business, results of operation, and financial condition may be materially and adversely affected.
In the past, we acquired companies to enhance the expansion of our business and products. We may consider selective opportunistic acquisitions of companies with resources and product or service offerings capable of providing us with additional strengths to help fulfill our vision of building the new, high-performance Internet. Acquisitions involve significant risks and uncertainties. These risks and uncertainties include:
53
Our inability to successfully operate and integrate newly-acquired businesses appropriately, effectively and in a timely manner could have a material adverse effect on our ability to take advantage of further growth in demand for IP-optimized network solutions and other advances in technology, as well as on our revenues, gross margins, and expenses.
We operate in highly dynamic and volatile industries characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, and short product life cycles.
The markets for our products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. We expect our success to depend, in substantial part, on the timely and successful introduction of high quality, new products and upgrades, as well as cost reductions on current products to address the operational speed, bandwidth, efficiency, and cost requirements of our customers. Our success will also depend on our ability to comply with emerging industry standards, to operate with products of other suppliers, to address emerging market trends, to provide our customers with new revenue-generating opportunities and to compete with technological and product developments carried out by others. The development of new, technologically advanced products, including IP-optimized networking solutions and 3G wireless networks, is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. Investments in such development may result in expenses growing at a faster rate than revenues. We may not be successful in targeting new market opportunities, in developing and commercializing new products in a timely manner, or in achieving market acceptance for our new products.
The success of new or enhanced products, including IP-optimized networking solutions and 3G wireless networks, depends on a number of other factors including the timely introduction of such products, market acceptance of new technologies and industry standards, the quality and robustness of new or enhanced products, competing product offerings, the pricing and marketing of such products, and the availability of funding for such networks. Products and technologies developed by our competitors may render our products obsolete. Hackers may attempt to disrupt or exploit our customers’ use of our technologies. If we fail to respond in a timely and effective manner to unanticipated changes in one or more of the technologies affecting telecommunications and data networking or our new products or product enhancements fail to achieve market acceptance, our ability to compete effectively in our industry, and our sales, market share, and customer relationships could be materially and adversely affected.
In addition, unanticipated changes in market demand for products based on a specific technology, particularly lower than anticipated, or delays in, demand for IP-optimized networking solutions, particularly long-haul and metro optical networking solutions, or 3G wireless networks, could have a material adverse effect on our business, results of operations, and financial condition if we fail to respond to such changes in a timely and effective manner.
We face significant competition and may not be able to maintain our market share and may suffer from competitive pricing practices.
We operate in a highly volatile industry that is characterized by vigorous competition for market share and rapid technological development. Competition is heightened in periods of slow overall market growth. These factors could result in aggressive pricing practices and growing competition from start-up companies, established competitors, as well as well-capitalized computer systems and communications companies, which, in turn, could have a material adverse effect on our gross margins.
Our principal competitors in the sale of our Metro and Enterprise Networks products to service providers are large communications companies such as Alcatel S.A., Fujitsu Limited, Telefonaktiebolagat LM Ericsson, Lucent Technologies Inc., and Siemens Aktiengesellschaft. In addition, we compete with smaller companies that address specific niches within this market, such as Ciena Corporation and ONI Systems Corp (who recently announced their intention to combine their companies), Sonus Systems Limited, and Redback Networks Inc. Our principal competitors in the sale of our Metro and Enterprise Networks solutions to enterprises are Alcatel, Avaya Inc., Cisco Systems, Inc., Ericsson, and Siemens. We also compete with smaller companies that address specific niches, such as Foundry Networks, Inc., Extreme Networks, Inc., Enterasys Networks, Inc., 3Com Corporation, and Genesys Telecommunications Laboratories, Inc. Our major competitors in the global wireless infrastructure business have traditionally included Ericsson, Lucent, Motorola, Inc., and Nokia Corporation. More recently, Siemens and Samsung Electronics Co., Ltd. have emerged as competitors. Our major
54
competitors in the sale of long-distance optical networking equipment include Alcatel, Ciena, Fujitsu, Lucent, and Marconi plc. Our major competitors in the sale of optical components includes Agere Systems Inc. and JDS Uniphase Corporation. Since some of the markets in which we compete are characterized by the potential for rapid growth and, in certain cases, low barriers to entry and rapid technological changes, smaller, specialized companies and start-up ventures are now or may become principal competitors in the future. We may also face competition from the resale of used telecommunications equipment, including our own on occasion, by failed, downsized or consolidated high technology enterprises and telecommunications service providers. In addition, one way to maximize market growth, enhance existing products and introduce new products is through acquisitions of companies, where advisable. Our acquisitions of other companies may cause certain of our competitors to enter into additional business combinations, to accelerate product development, or to engage in aggressive price reductions or other competitive practices, creating even more powerful or aggressive competitors.
We expect that we will face additional competition from existing competitors and from a number of companies that have entered or may enter our existing and future markets. Some of our current and potential competitors have greater marketing, technical and financial resources, including the ability to provide customer financing in connection with the sale of products. Many of our current and potential competitors have also established, or may in the future establish, relationships with our current and potential customers. Increased competition could result in price reductions, negatively affecting our operating results, reducing profit margins and potentially leading to a loss of market share.
We face certain barriers in our efforts to expand internationally.
We intend to continue to pursue international and emerging market growth opportunities. In many international markets, long-standing relationships between potential customers and their local service providers and protective regulations, including local content requirements and type approvals, create barriers to entry. In addition, pursuing international opportunities may require significant investments for an extended period before we realize returns on such investments, if any, and such investments may result in expenses growing at a faster rate than revenues. Furthermore, such projects and investments could be adversely affected by:
Difficulties in foreign financial markets and economies and of foreign financial institutions, particularly in emerging markets, could adversely affect demand from customers in the affected countries. An inability to maintain or expand our business in international and emerging markets could have a material adverse effect on our business, results of operations, and financial condition.
55
Fluctuating foreign currencies may negatively impact our business, results of operations, and financial condition.
As an increasing proportion of our business may be denominated in currencies other than United States dollars, fluctuations in foreign currencies may have an impact on our business, results of operations, and financial condition. Our primary currency exposures are to Canadian dollars, United Kingdom pounds, and the Euro. These exposures may change over time as we change the geographic mix of our global business and as our business practices evolve. For instance, if we increase our presence in emerging markets, we may see an increase in our exposure to such emerging market currencies, such as, for example, the Chinese renminbi. These currencies may be affected by internal factors, and external developments in other countries, all of which can have an adverse impact on a country’s currency. We cannot predict whether foreign exchange losses will be incurred in the future, and significant foreign exchange fluctuations may have a material adverse effect on our results of operations.
We may become involved in disputes regarding intellectual property rights that could materially and adversely affect our business if we do not prevail.
Our industry is subject to uncertainty over adoption of industry standards and protection of intellectual property rights. Our success is dependent on our proprietary technology, which we rely on patent, copyright, trademark and trade secret laws to protect. While our business is global in nature, the level of protection of our proprietary technology provided by such laws varies by country. Our issued patents may be challenged, invalidated, or circumvented, and our rights under issued patents may not provide us with competitive advantages. Patents may not be issued from pending applications, and claims in patents issued in the future may not be sufficiently broad to protect our proprietary technology. In addition, claims of intellectual property infringement or trade secret misappropriation may be asserted against us or our customers in connection with their use of our products, and the outcome of any such claims are uncertain. A failure by us to react to changing industry standards, the lack of broadly-accepted industry standards, successful claims of intellectual property infringement or other intellectual property claims against us or our customers, or a failure by us to protect our proprietary technology, could have a material adverse effect on our business, results of operations, and financial condition. In addition, if others infringe on our intellectual property rights, we may not be able to successfully contest such challenges.
Rationalization and consolidation in the telecommunications industry may cause us to experience a loss of customers.
The telecommunications industry has experienced the consolidation and rationalization of industry participants and we expect this trend to continue. There have been adverse changes in the public and private equity and debt markets for telecommunications industry participants which have affected their ability to obtain financing or to fund capital expenditures. Some operators have experienced financial difficulty and have, or may, file for bankruptcy protection or be acquired by other operators. Other operators may merge and we and one or more of our competitors may each supply products to the companies that have merged or will merge. This rationalization/consolidation could result in our dependence on a smaller number of customers, purchasing decision delays by the merged companies and/or our playing a lesser role, or no longer playing a role, in the supply of communications products to the merged companies. In addition, telecommunications equipment suppliers may enter into business combinations, or may be acquired by or sell a substantial portion of their assets to other competitors, resulting in accelerated product development, increased financial strength, or a broader base of customers, creating even more powerful or aggressive competitors. We may also see rationalization among equipment suppliers. The business failures of operators, competitors or suppliers may cause uncertainty among investors and in the telecommunications market generally.
Changes in regulation of the Internet may affect the manner in which we conduct our business and may materially and adversely affect our business, results of operations, and financial condition.
There are currently few domestic or international laws or regulations that apply directly to access to or commerce on the Internet. We could be materially and adversely affected by regulation of the Internet in any country where we operate in respect of such technologies as voice over the Internet, encryption technology and access charges for Internet service providers. We could also be materially and adversely affected by increased competition as a result of the continuing deregulation of the telecommunications industry. If a jurisdiction in which we operate adopts measures which affect the regulation of the Internet or the deregulation of the telecommunications industry, we could experience both decreased
56
demand for our products and increased costs of selling such products. Changes in laws or regulations governing the Internet and Internet commerce could have a material adverse effect on our business, results of operations, and financial condition.
Nortel Networks Corporation’s stock price has historically been volatile and a major decline in the market price of Nortel Networks Corporation’s common shares or our other securities may negatively impact our ability to make future strategic acquisitions, raise capital, issue debt, or retain employees.
Nortel Networks Corporation’s common shares have experienced, and may continue to experience, substantial price volatility, including decreases, particularly as a result of variations between our actual or anticipated financial results and the published expectations of analysts and as a result of announcements by our competitors and us. In addition, the stock markets have experienced extreme price fluctuations that have affected the market price of many technology companies in particular. These price fluctuations have in some cases been unrelated to the operating performance of these companies. A major decline in the capital markets generally, or in the market price of Nortel Networks Corporation’s common shares or our other securities, may negatively impact our ability to make future strategic acquisitions, raise capital, issue debt, or retain employees. These factors, as well as general economic and political conditions, may in turn have a material adverse effect on the market price of Nortel Networks Corporation’s common shares.
We have provided and may continue to provide significant financing to our customers. The current downturn in the economy increases our exposure to our customers’ credit risk and the risk that our customers will not be able to fulfill their payment obligations.
The competitive environment in which we operate has required us in the past, and we expect may continue to require us in the future, to provide significant amounts of medium-term and long-term customer financing. Customer financing arrangements may include financing in connection with the sale of our products and services, funding for certain non-product and service costs associated with network installation and integration of our products and services, financing for working capital and equity financing. We may provide customer financing in the future for such customer requirements as turnkey construction of new networks, particularly for 3G wireless operators. If we do, we may be required to directly support a significantly greater amount of such financings than in the past, when we were able to place a large amount of our customer financing obligations with third party lenders.
We expect to continue to hold certain current and future customer financing obligations for longer periods prior to any possible placement with third-party lenders, due to, among other factors, recent economic uncertainty in various countries, capital market conditions, adverse changes in the credit ratings of our customers or ourselves, and reduced demand for telecommunications financing in capital and bank markets. In addition, risks generally associated with customer financing, including the risks associated with new technologies, new network construction, market demand and competition, customer business plan viability and funding risks, may require us to hold certain customer financing obligations over a longer term. We may not be able to place any of our current or future customer financing obligations with third-party lenders on acceptable terms.
Recently, certain of our customers, including a number of competitive local exchange carriers, have been experiencing financial difficulties, and during the third and fourth quarters of 2001, we noted the amount of customer financing with respect to which customers that have failed to meet their financing obligations had increased. If there is further increase in the failure of our customers to meet their customer financing obligations to us, we could incur losses in excess of our provisions, which could have a material adverse effect on our cash flow and operating results.
Negative developments associated with our supply and outsourcing contracts, turnkey arrangements and contract manufacturing agreements may materially and adversely affect our business, results of operations, financial condition, and supply relationships.
We have entered into supply contracts with customers to provide products and services, which in some cases involve new technologies currently being developed, or which we have not yet commercially deployed, or which require us to build and operate networks on a turnkey basis. We have also entered into network outsourcing contracts with customers to operate their networks. Some of these supply and network outsourcing contracts contain delivery and installation timetables, performance criteria and other contractual obligations which, if not met, could result in our having to pay substantial
57
penalties or liquidated damages, the termination of the related supply or network outsourcing contract, and/or the reduction of shared revenues under a turnkey arrangement, in certain circumstances. Unexpected developments in these supply and outsourcing contracts could have a material adverse effect on our revenues, cash flows, and relationships with our customers.
Our ability to meet customer demand is, in part, dependent on us obtaining timely and adequate component parts and products from suppliers, contract manufacturers, and internal manufacturing capacity. As part of the transformation of our supply chain from a vertically integrated manufacturing model to a virtually integrated model, we have outsourced a substantial portion of our manufacturing capacity to contract manufacturers. We work closely with our suppliers and contract manufacturers to address quality issues and to meet increases in customer demand, when needed, and we also manage our internal manufacturing capacity, quality, and inventory levels as required. However, we may encounter shortages of quality components and/or products in the future. In addition, our component suppliers and contract manufacturers have experienced, and may continue to experience, a consolidation in the industry, which may result in fewer sources of components or products and greater exposure to the financial stability of our suppliers. A reduction or interruption in component supply or external manufacturing capacity, a significant increase in the price of one or more components, or excessive inventory levels could materially and negatively affect our gross margins and our operating results.
Our business may suffer if strategic alliances which we have entered into are not successful.
We have entered into a number of strategic alliances with suppliers, developers, and members in our industry to facilitate product compatibility, encourage adoption of industry standards, or to offer complementary product or service offerings to meet customer needs. In some cases, the companies with which we have strategic alliances also compete against us in some of our business areas. If a member of a strategic alliance fails to perform its obligations, if the relationship fails to develop as expected, or if the relationship is terminated, we could experience delays in product availability or impairment of our relationships with our customers.
The adverse resolution of litigation against us could negatively impact our business.
We are currently a defendant in numerous class actions and other lawsuits, including lawsuits initiated on behalf of holders of Nortel Networks Corporation’s common shares, which seek damages of material and indeterminate amounts, as well as lawsuits in the normal course of business. We are and may in the future be subject to other litigation arising in the normal course of our business. Litigation may be time consuming, expensive, and distracting from the conduct of our business, and the outcome of litigation is difficult to predict. The adverse resolution of any specific lawsuit could have a material adverse effect on our business, results of operations, and financial condition.
Recent pronouncements
For a discussion of recent pronouncements, see “Significant accounting policies” in note 2(q) to the accompanying audited consolidated financial statements and notes thereto.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to “Market risk” in “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
58
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
59
INDEPENDENT AUDITORS’ REPORT
To the Shareholders of Nortel Networks Corporation
We have audited the accompanying consolidated balance sheets of Nortel Networks Corporation and its subsidiaries (“Nortel Networks”) as at December 31, 2001 and 2000 and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2001. These financial statements are the responsibility of Nortel Networks management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Nortel Networks as at December 31, 2001 and 2000 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
We also reported separately on February 1, 2002, to the shareholders of Nortel Networks, on our audits, conducted in accordance with Canadian generally accepted auditing standards, where we expressed an opinion without reservation on the December 31, 2001 and 2000 consolidated financial statements, prepared in accordance with Canadian generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLPChartered Accountants
Toronto, CanadaFebruary 1, 2002
F-1
NORTEL NETWORKS CORPORATIONConsolidated Statements of OperationsYears Ended December 31(millions of U.S. dollars, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
F-2
NORTEL NETWORKS CORPORATIONConsolidated Balance SheetsAs at December 31(millions of U.S. dollars)
F-3
NORTEL NETWORKS CORPORATIONConsolidated Statements of Shareholders’ Equity(millions of U.S. dollars)
F-4
NORTEL NETWORKS CORPORATIONConsolidated Statements of Cash FlowsYears Ended December 31(millions of U.S. dollars)
F-5
NORTEL NETWORKS CORPORATIONNotes to Consolidated Financial Statements(millions of U.S. dollars, except per share amounts, unless otherwise stated)
F-6
F-7
F-8
F-9
F-10
F-11
F-12
F-13
Purchase price allocation and amortization period for intangible assets
F-14
F-15
F-16
F-17
F-18
F-19
F-20
F-21
F-22
F-23
F-24
F-25
F-26
F-27
F-28
F-29
F-30
F-31
The initial issuance of the rights did not alter the financial condition of Nortel Networks, impede its business plans, or alter its Consolidated Financial Statements. The initial issuance of the rights was not dilutive. However, if a “Flip-In Event” (as defined in the Rights Plan) occurs and the rights separate from the Nortel Networks common shares as described in the Rights Plan, reported earnings (loss) per share may be affected. In addition, holders of rights not exercising their rights after a Flip-In Event may suffer substantial dilution.
F-32
F-33
F-34
F-35
F-36
F-37
F-38
F-39
F-40
F-41
F-42
F-43
F-44
F-45
F-46
F-47
F-48
QUARTERLY FINANCIAL DATA (unaudited)
F-49
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by reference to Nortel Networks proxy circular and proxy statement filed with the Commission on March 11, 2002 pursuant to Regulation 14A. Such incorporation by reference shall be deemed not to specifically incorporate by reference the information referred to in Item 402(a)(8) of Regulation S-K, contained under the captions “Joint Board Compensation Committee Report on Executive Compensation of Nortel Networks Corporation and Nortel Networks Limited”, “Shareholder Return Performance Graph” and “Report of the Audit Committee of Nortel Networks Corporation”.
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
60
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
61
62
63
64
65
66
67
68
We have audited the consolidated financial statements of Nortel Networks Corporation and its subsidiaries (“Nortel Networks”) as at December 31, 2001 and 2000, and for each of the three years in the period ended December 31, 2001, and have issued our report thereon dated February 1, 2002; such financial statements and report are included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of Nortel Networks listed in Item 14. This financial statement schedule is the responsibility of Nortel Networks management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
69
Schedule IIConsolidated
NORTEL NETWORKS CORPORATIONValuation and Qualifying Accounts and ReservesProvision for Uncollectibles*(millions of U.S. dollars)
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Brampton, Ontario, Canada on the 11th day of March, 2002.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 11th day of March, 2002.
71
Directors:
72
Exhibit 21
Subsidiaries of the Registrant
Significant subsidiary companies of the Registrant at December 31, 2001, were:
73