Draft versions of Nortel Network Corp.'s financial statements for the second quarter of 2003 show profits yo-yoing as senior staff booked, reversed and then re-booked various accounting reserves while working on completing the books for the period.
Former Nortel director of finance Michael McMillan testified Tuesday at the fraud trial of three former top executives about a confusing week for Nortel's accounting staff in July, 2003, as they adjusted accounting reserves repeatedly while closing the books on the company's second quarter.
The changes pushed Nortel from a large operating loss for the period to an unexpectedly large profit, then back down to a smaller profit that was in line with earlier forecasts, court heard.
The Crown has contended the changes were part of an effort by former chief executive officer Frank Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly to manipulate and fine-tune Nortel's profits to earn special "return to profitability" bonuses for executives.
Lawyers for the men have denied the allegations and have argued the use of accounting reserves was appropriate at the time and was approved by Nortel's external auditors at Deloitte & Touche.
In early July, 2003, the company had prepared a draft of its second-quarter financial statements that included using $514-million worth of accounting provisions, the trial has heard. The reserves pushed Nortel from a large operating loss to an internal "pro forma" profit of $186-million for the second quarter.
The projected profit was far higher than the $50-million the company had been forecasting for the quarter.
Mr. McMillan testified Tuesday he was asked on July 7 to do a review of a portion of the accounting reserves that had been released to see if that decision was appropriate.
Mr. McMillan said he looked at the head office non-operating reserves in particular. His analysis, completed within a few days, concluded that $142-million of the reserves were not supportable.
The $142-million did not have supporting documentation to justify their existence, or else did not have a "trigger" in that quarter to justify unwinding them at that time, he said.
The company decided not to release the reserves after all, he said. Days after originally booking the release of the provisions, Nortel reversed the entries from its books on July 10.
The Crown has contended the review was undertaken at the last minute and the provisions were reversed only because senior executives realized its profit would be too high and out of line with forecasts.
Mr. McMillan testified he asked Mr. Gollogly to sign authorization for the July 10 reversals because it involved such a large sum of money.
"From a profit and loss perspective, $142-million was quite significant to our income," he testified. "I think my concern was on the profit and loss side of the entry."
The reversal had the impact of reducing Nortel's internal "pro forma" income to $35-million and its bottom line reported net income to a loss of $14-million.
The following day, July 11, Mr. McMillan testified his staff was asked to add about $20-million more of reserves back into income. The decision had the impact of moving the $14-million net loss to a profit of $6-million, the Crown has alleged.
Mr. McMillan said the amount of money involved was not large, but it was significant because it transformed a bottom-line loss for the quarter into a profit.
The request came from Mr. Beatty, he said, and occurred on a Friday when Mr. Gollogly was out of the office.
Mr. McMillan said Mr. Gollogly returned to the office the following Monday and appeared unhappy with the decision to use the $23-million of provisions. He told Mr. McMillan to reverse the entries, he said, returning the bottom line to a loss of $14-million.
That amount was later reported as Nortel's loss for the period.
But the $35-million internal "pro forma" income was enough to pay the return to profitability bonuses to executives and to trigger payouts under the company's restricted share unit plan, the court has heard.
The case is being heard by Mr. Justice Frank Marrocco of the Ontario Superior Court.