Annual Reports

 
Quarterly Reports

  • 10-Q (Aug 10, 2012)
  • 10-Q (May 10, 2012)
  • 10-Q (Nov 14, 2011)
  • 10-Q (Sep 9, 2011)
  • 10-Q (Aug 11, 2011)
  • 10-Q (May 16, 2011)

 
8-K

 
Other

Nortel Networks 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-10.1
  3. Ex-12
  4. Ex-31.1
  5. Ex-31.2
  6. Ex-32
  7. Ex-32
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From              to             

Commission File Number: 001-07260

Nortel Networks Corporation

(Exact name of registrant as specified in its charter)

 

Canada   98-0535482

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

195 The West Mall

Toronto, Ontario, Canada

  M9C 5K1
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number Including Area Code (905) 863-7000

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 such filing requirements for the past 90 days.

Yes  þ    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  þ      Accelerated filer ¨           

Non-accelerated filer  ¨

(Do not check if a smaller
reporting company)

       Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of October 27, 2008.

497,496,792 shares of common stock without nominal or par value

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          PAGE

PART I

FINANCIAL INFORMATION

  

ITEM 1.

  

Condensed Consolidated Financial Statements (unaudited)

   1

ITEM 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   55

ITEM 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   115

ITEM 4.

  

Controls and Procedures

   116

PART II

OTHER INFORMATION

  

ITEM 1.

  

Legal Proceedings

   117

ITEM 1A.

  

Risk Factors

   117

ITEM 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   120

ITEM 6.

  

Exhibits

   121

SIGNATURES

   122

All dollar amounts in this document are in United States Dollars unless otherwise stated.

NORTEL, NORTEL (Logo), NORTEL NETWORKS, The GLOBEMARK, and NT are trademarks of Nortel Networks.

MOODY’S is a trademark of Moody’s Investors Service, Inc.

NYSE is a trademark of the New York Stock Exchange, Inc.

S&P and STANDARD & POOR’S are trademarks of The McGraw-Hill Companies, Inc.

All other trademarks are the property of the respective owners.

 

i


Table of Contents

PART I

FINANCIAL INFORMATION

 

ITEM 1. Condensed Consolidated Financial Statements (unaudited)

NORTEL NETWORKS CORPORATION

Condensed Consolidated Statements of Operations (unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2008     2007     2008     2007  
    

(Millions of U.S. Dollars,

except per share amounts)

 

Revenues:

        

Products

   $ 2,006     $ 2,378     $ 6,765     $ 6,793  

Services

     313       327       934       957  
                                

Total revenues

     2,319       2,705       7,699       7,750  
                                

Cost of revenues:

        

Products

     1,243       1,384       4,022       4,024  

Services

     168       158       493       509  
                                

Total cost of revenues

     1,411       1,542       4,515       4,533  
                                

Gross profit

     908       1,163       3,184       3,217  

Operating expenses:

        

Selling, general and administrative expense

     514       613       1,686       1,812  

Research and development expense

     377       416       1,238       1,248  

Amortization of intangible assets

     11       12       34       37  

Special charges

     50       56       205       172  

Loss (gain) on sales of businesses and assets

     (6 )     3       (10 )     (8 )

Shareholder litigation settlement recovery

     —         —         —         (54 )

Regulatory investigation expense

     —         —         —         35  

Goodwill impairment (note 4)

     1,142       —         1,142       —    

Other operating expense (income)—net (note 3)

     8       (7 )     14       (29 )
                                

Total operating expenses

     2,096       1,093       4,309       3,213  
                                

Operating earnings (loss)

     (1,188 )     70       (1,125 )     4  

Other income (expense)—net (note 3)

     (21 )     95       (19 )     156  

Interest and dividend income

     27       61       95       176  

Interest expense

        

Long-term debt

     (78 )     (102 )     (225 )     (278 )

Other

     (3 )     (5 )     (12 )     (23 )
                                

Earnings (loss) from operations before income taxes, minority interests and equity in net earnings of associated companies

     (1,263 )     119       (1,286 )     35  

Income tax expense (note 7)

     (2,129 )     (50 )     (2,226 )     (74 )
                                
     (3,392 )     69       (3,512 )     (39 )

Minority interests—net of tax

     (21 )     (43 )     (154 )     (76 )

Equity in net earnings of associated companies—net of tax

     —         1       2       2  
                                

Net earnings (loss)

   $ (3,413 )   $ 27     $ (3,664 )   $ (113 )
                                

Basic and diluted earnings (loss) per common share

   $ (6.85 )   $ 0.05     $ (7.36 )   $ (0.24 )
                                

The accompanying notes are an integral part of these condensed consolidated financial statements

 

1


Table of Contents

NORTEL NETWORKS CORPORATION

Condensed Consolidated Balance Sheets (unaudited)

 

     September 30,
2008
    December 31,
2007
 
     (Millions of U.S. Dollars,
except for share amounts)
 
ASSETS  

Current assets

    

Cash and cash equivalents

   $ 2,304     $ 3,532  

Short-term investments

     346       —    

Restricted cash and cash equivalents

     52       76  

Accounts receivable—net

     1,951       2,583  

Inventories—net

     1,722       2,002  

Deferred income taxes—net

     290       487  

Other current assets

     462       467  
                

Total current assets

     7,127       9,147  

Investments

     163       194  

Plant and equipment—net

     1,406       1,532  

Goodwill

     1,411       2,559  

Intangible assets—net

     167       213  

Deferred income taxes—net

     829       2,868  

Other assets

     506       555  
                

Total assets

   $ 11,609     $ 17,068  
                
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)  

Current liabilities

    

Trade and other accounts payable

   $ 1,056     $ 1,187  

Payroll and benefit-related liabilities

     541       690  

Contractual liabilities

     214       272  

Restructuring liabilities

     117       100  

Other accrued liabilities (note 3)

     2,869       3,825  

Long-term debt due within one year

     20       698  
                

Total current liabilities

     4,817       6,772  

Long-term debt

     4,465       3,816  

Deferred income taxes—net

     15       17  

Other liabilities (note 3)

     2,496       2,875  
                

Total liabilities

     11,793       13,480  
                

Minority interests in subsidiary companies

     883       830  

Guarantees, commitments, contingencies and subsequent events
(notes 11, 13, 18 and 19 respectively)

    
SHAREHOLDERS’ EQUITY (DEFICIT)  

Common shares, without par value—Authorized shares: unlimited; Issued and outstanding shares: 497,456,640 and 437,423,006 as of September 30, 2008 and December 31, 2007, respectively

     35,581       34,028  

Additional paid-in capital

     3,538       5,025  

Accumulated deficit

     (40,229 )     (36,532 )

Accumulated other comprehensive income

     43       237  
                

Total shareholders’ equity (deficit)

     (1,067 )     2,758  
                

Total liabilities and shareholders’ equity (deficit)

   $ 11,609     $ 17,068  
                

The accompanying notes are an integral part of these condensed consolidated financial statements

 

2


Table of Contents

NORTEL NETWORKS CORPORATION

Condensed Consolidated Statements of Cash Flows (unaudited)

 

     Nine Months Ended
September 30,
 
           2008                 2007        
     (Millions of U.S. Dollars)  

Cash flows from (used in) operating activities

    

Net loss

   $ (3,664 )   $ (113 )

Adjustments to reconcile net loss to net cash used in operating activities

    

Amortization and depreciation

     254       231  

Goodwill impairment

     1,142       —    

Non-cash portion of shareholder litigation settlement recovery

     —         (54 )

Non-cash portion of special charges

     13       3  

Equity in net earnings of associated companies—net of tax

     (2 )     (2 )

Share-based compensation expense

     64       86  

Deferred income taxes

     2,113       (8 )

Pension and other accruals

     85       200  

Loss (gain) on sales and write downs of investments, businesses and assets—net

     10       (3 )

Minority interests—net of tax

     154       76  

Other—net

     (56 )     (187 )

Changes in operating assets and liabilities

    

Other (note 3)

     (591 )     (464 )

Global Class Action Settlement—net

     —         (585 )
                

Net cash used in operating activities

     (478 )     (820 )
                

Cash flows from (used in) investing activities

    

Expenditures for plant and equipment

     (129 )     (140 )

Proceeds on disposals of plant and equipment

     —         89  

Change in restricted cash and cash equivalents

     23       575  

Increase in short-term and long-term investments

     (362 )     —    

Acquisitions of investments and businesses—net of cash acquired

     (110 )     (81 )

Proceeds from the sales of investments and businesses and assets—net

     (16 )     (29 )
                

Net cash from (used in) investing activities

     (594 )     414  
                

Cash flows from (used in) financing activities

    

Dividends paid by subsidiaries to minority interests

     (30 )     (35 )

Increase in notes payable

     116       47  

Decrease in notes payable

     (107 )     (52 )

Proceeds from issuance of long-term debt

     668       1,150  

Repayments of long-term debt

     (675 )     (1,125 )

Debt issuance costs

     (13 )     (23 )

Repayments of capital leases payable

     (17 )     (18 )

Issuance of common shares

     —         10  
                

Net cash from (used in) financing activities

     (58 )     (46 )
                

Effect of foreign exchange rate changes on cash and cash equivalents

     (98 )     88  
                

Net increase (decrease) in cash and cash equivalents

     (1,228 )     (364 )

Cash and cash equivalents at beginning of period

     3,532       3,492  
                

Cash and cash equivalents at end of period

   $ 2,304     $ 3,128  
                

The accompanying notes are an integral part of these condensed consolidated financial statements

 

3


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)

(Millions of U.S. Dollars, except per share amounts, unless otherwise stated)

 

1. Significant accounting policies

Basis of presentation

The unaudited condensed consolidated financial statements of Nortel Networks Corporation (“Nortel”) have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and the rules and regulations of the United States (“U.S.”) Securities and Exchange Commission (the “SEC”) for the preparation of interim financial information. They do not include all information and notes required by U.S. GAAP in the preparation of annual consolidated financial statements. The accounting policies used in the preparation of the unaudited condensed consolidated financial statements are the same as those described in Nortel’s audited consolidated financial statements prepared in accordance with U.S. GAAP for the year ended December 31, 2007, except as discussed in note 2. The condensed consolidated balance sheet as of December 31, 2007 is derived from the December 31, 2007 audited consolidated financial statements. Although Nortel is headquartered in Canada, the unaudited condensed consolidated financial statements are expressed in U.S. Dollars as the greater part of the financial results and net assets of Nortel are denominated in U.S. Dollars.

Nortel makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Estimates are used when accounting for items and matters such as revenue recognition and accruals for losses on contracts, allowances for uncollectible accounts receivable, inventory provisions and outsourcing-related obligations, product warranties, estimated useful lives of intangible assets and plant and equipment, asset valuations, impairment assessments, employee benefits including pensions, taxes and related valuation allowances and provisions, restructuring and other provisions, share-based compensation and contingencies.

Nortel believes all adjustments necessary for a fair statement of the results for the periods presented have been made and all such adjustments were of a normal recurring nature unless otherwise disclosed. The financial results for the three and nine months ended September 30, 2008 are not necessarily indicative of financial results for the full year. The unaudited condensed consolidated financial statements should be read in conjunction with Nortel’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC and Canadian securities regulatory authorities (the “2007 Annual Report”).

Comparative figures

Certain 2007 figures in the unaudited condensed consolidated financial statements have been reclassified to conform to Nortel’s current presentation, as set out in notes 3 and 5.

Recent accounting pronouncements

 

  (i)

In September 2006, the United States Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a single definition of fair value, a framework for measuring fair value under U.S. GAAP and requires expanded disclosures about fair value measurements. Nortel partially adopted the provisions of SFAS 157 effective January 1, 2008; see note 2. The effective date for SFAS 157 as it relates to fair value measurements for non-financial assets and liabilities that are not measured at fair value on a recurring basis has been deferred to fiscal years beginning after December 15, 2008 in accordance with FASB Staff Position (“FSP”), SFAS 157-2, “Effective Date of FASB Statement No. 157”. Nortel plans to adopt the deferred portion of SFAS 157 on January 1, 2009.

 

4


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

 

Nortel does not currently expect the adoption of the deferred portion of SFAS 157 to have a material impact on its results of operations and financial condition, but will continue to assess the impact as the guidance evolves.

 

  (ii) In September 2007, the FASB Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 07-1, “Collaborative Arrangements” (“EITF 07-1”). EITF 07-1 addresses the accounting for arrangements in which two companies work together to achieve a common commercial objective, without forming a separate legal entity. The nature and purpose of a company’s collaborative arrangements are required to be disclosed, along with the accounting policies applied and the classification and amounts for significant financial activities related to the arrangements. Nortel plans to adopt the provisions of EITF 07-1 on January 1, 2009. The adoption of EITF 07-1 is not expected to have a material impact on Nortel’s results of operations and financial condition.

 

  (iii) In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”), replacing SFAS No. 141, “Business Combinations”. SFAS 141R revises existing accounting guidance for how an acquirer recognizes and measures in its financial statements the identifiable assets, liabilities, any noncontrolling interests and goodwill acquired on the acquisition of a business. SFAS 141R is effective for fiscal years beginning after December 15, 2008. Nortel plans to adopt the provisions of SFAS 141R on January 1, 2009. The adoption of SFAS 141R will impact the accounting for business combinations completed by Nortel on or after January 1, 2009.

 

  (iv) In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for the treatment of noncontrolling interests in a subsidiary. Noncontrolling interests in a subsidiary will be reported as a component of equity in the consolidated financial statements and any retained noncontrolling equity investment upon deconsolidation of a subsidiary is initially measured at fair value. SFAS 160 is effective for fiscal years beginning after December 15, 2008. Nortel plans to adopt the provisions of SFAS 160 on January 1, 2009. The adoption of SFAS 160 will result in the reclassification of minority interests to shareholders’ equity. Nortel is currently assessing any further impacts of SFAS 160 on its results of operations and financial condition.

 

  (v) In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—An Amendment of FASB Statement 133” (“SFAS 161”). SFAS 161 requires expanded and enhanced disclosure for derivative instruments, including those used in hedging activities. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. Nortel plans to adopt the provisions of SFAS 161 on January 1, 2009. Nortel is currently assessing the impact, if any, of the adoption of SFAS 161 on its consolidated financial statement disclosures.

 

  (vi) In April 2008, the FASB issued FSP SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP SFAS 142-3”). FSP SFAS 142-3 provides guidance with respect to estimating the useful lives of recognized intangible assets acquired on or after the effective date and requires additional disclosure related to the renewal or extension of the terms of recognized intangible assets. FSP SFAS 142-3 is effective for fiscal years and interim periods beginning after December 15, 2008. Nortel plans to adopt the provisions of FSP SFAS 142-3 on January 1, 2009. Nortel is currently assessing the impact, if any, of the adoption of FSP SFAS 142-3 on its results of operations and financial condition.

 

  (vii)

In June 2008, the EITF reached a consensus on EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 addresses the determination of whether an equity linked financial instrument (or embedded feature) that has all of the characteristics of a derivative under other authoritative U.S. GAAP accounting

 

5


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

 

literature is indexed to an entity’s own stock and would thus meet the first part of a scope exception from classification and recognition as a derivative instrument. Nortel plans to adopt the provisions of EITF 07-5 on January 1, 2009. Nortel is currently assessing the impact of the adoption of EITF 07-5, if any, on its results of operations and financial condition.

 

  (viii) In September 2008, the FASB issued FSP 133-1 and FASB Interpretation Number (“FIN”) 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161” (“FSP 133-1 and FIN 45-4”). FSP 133-1 and FIN 45-4 amend and enhance disclosure requirements for sellers of credit derivatives and financial guarantees. They also clarify that the disclosure requirements of SFAS No. 161 are effective for quarterly periods beginning after November 15, 2008, and fiscal years that include those periods. FSP 133-1 and FIN 45-4 are effective for reporting periods (annual or interim) ending after November 15, 2008. Nortel’s adoption of these standards will not have a material impact on its consolidated financial statements disclosures.

 

  (ix) In September 2008, the EITF ratified EITF Issue No. 08-5, “Issuer’s Accounting for Liabilities Measured at Fair Value With a Third-Party Credit Enhancement” (“EITF 08-5”). EITF 08-5 provides guidance for measuring liabilities issued with an attached third-party credit enhancement (such as a guarantee). It clarifies that the issuer of a liability with a third-party credit enhancement (such as a guarantee) should not include the effect of the credit enhancement in the fair value measurement of the liability. EITF 08-5 is effective for the first reporting period beginning after December 15, 2008. Nortel is currently assessing the impact of EITF 08-5 on its result of operations and financial condition.

 

2. Accounting changes

The Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 allows the irrevocable election of fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities and other items on an instrument-by-instrument basis. Changes in fair value would be reflected in earnings as they occur. The objective of SFAS 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. For Nortel, SFAS 159 was effective as of January 1, 2008. Nortel has elected not to apply the fair value option to any of its eligible financial instruments and other items.

Fair Value Measurements

In September 2006, the FASB issued SFAS 157, which establishes a single definition of fair value and a framework for measuring fair value and requires expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. In accordance with the standard, Nortel partially adopted the provisions of SFAS 157 effective January 1, 2008.

In October 2008, the FASB issued FSP 157-3 “Determining Fair Value of a Financial Asset in a Market That Is Not Active” (“FSP 157-3”). FSP 157-3 clarifies the application of SFAS No. 157 in an inactive market by demonstrating how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP 157-3 was effective upon issuance, including prior periods for which the condensed consolidated financial statements had not been issued. Nortel has adopted the provisions of SFAS 157-3 effective September 30, 2008. See note 12 for Nortel’s fair value information.

 

6


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an Amendment of FASB Statements No. 87, 88, 106, and 132(R)

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an Amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”). Effective for fiscal years ending after December 15, 2006, SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit pension and post-retirement plan (other than a multi- employer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Nortel adopted these requirements in fiscal 2006.

Effective for fiscal years ending after December 15, 2008, SFAS 158 requires Nortel to measure the funded status of its plans as of the date of its year end statement of financial position, being December 31. Nortel has historically measured the funded status of its significant plans on September 30. SFAS 158 provides two approaches for an employer to transition to a fiscal year end measurement date. Nortel has adopted the second approach, whereby Nortel continues to use the measurements determined for the December 31, 2007 fiscal year end reporting to estimate the effects of the transition. Under this approach, the net periodic benefit cost (exclusive of any curtailment or settlement gain or loss) for the period between the earlier measurement date, being September 30, 2007, and the end of the fiscal year that the new measurement date provisions are applied, being December 31, 2008, shall be allocated proportionately between amounts to be recognized as an adjustment to opening accumulated deficit in 2008 and the net periodic benefit cost for the fiscal year ending December 31, 2008. The adoption has resulted in an increase in accumulated deficit of $33, net of taxes, and an increase in accumulated other comprehensive income of $5, net of taxes, as of January 1, 2008.

For additional information on Nortel’s pension and post-retirement plans, see note 8.

 

3. Condensed consolidated financial statement details

The following tables provide details of selected items presented in the condensed consolidated statements of operations and cash flows, and the condensed consolidated balance sheets. For further information with respect to the accounting policies used in the preparation of the condensed consolidated financial statement details below, refer to the 2007 Annual Report and note 2.

Condensed consolidated statements of operations

Other operating expense (income)—net:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2008             2007(a)             2008             2007(a)      

Royalty license income—net

   $ (9 )   $ (6 )   $ (25 )   $ (20 )

Litigation charges (recovery)—net

     —         —         11       (8 )

Other—net

     17       (1 )     28       (1 )
                                

Other operating expense (income)—net

   $ 8     $ (7 )   $ 14     $ (29 )
                                

 

(a) Includes items that were previously reported as non-operating and that have been reclassified from “Other income—net” to conform to current presentation.

 

7


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Other income (expense)—net:

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
         2008             2007            2008             2007      

Loss on sale and write downs of investments

   $ (4 )   $ —      $ (6 )   $ (5 )

Currency exchange gains (losses)—net

     (7 )     67      8       136  

Other—net

     (10 )     28      (21 )     25  
                               

Other income (expense)—net

   $ (21 )   $ 95    $ (19 )   $ 156  
                               

Hedge ineffectiveness related to designated hedging relationships that were accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, had no material impact on the net loss for the three and nine months ended September 30, 2008 or 2007, and is reported within Other income (expense)—net in the condensed consolidated statements of operations.

Condensed consolidated balance sheets

Short-term investments:

Short-term investments as of September 30, 2008 consist of an investment having an original cost of $362 in a money market fund that was previously classified as cash and cash equivalents. Due to the current financial market conditions which resulted in the suspension of trading in the fund’s securities, an impairment of $10 was recorded to reflect the decline in the net asset value of the fund, and the balance has been re-classified as a short-term investment. Additionally, another $6 of this investment has been classified to long-term investments given the market uncertainties involving the expected period of redemption. See note 12 for further information on fair value of the investment and note 19 for a subsequent event related to the investment.

Accounts receivable—net:

     September 30,
2008
    December 31,
2007
 

Trade receivables

   $ 1,655     $ 2,277  

Notes receivable

     3       12  

Contracts in process

     336       356  
                
     1,994       2,645  

Less: provisions for doubtful accounts

     (43 )     (62 )
                

Accounts receivable—net

   $ 1,951     $ 2,583  
                

Inventories—net:

     September 30,
2008
    December 31,
2007
 

Raw materials

   $ 363     $ 610  

Work in process

     11       10  

Finished goods

     862       800  

Deferred costs

     1,312       1,698  
                
     2,548       3,118  

Less: provision for inventories

     (663 )     (907 )
                

Inventories—net

     1,885       2,211  

Less: long-term deferred costs(a)

     (163 )     (209 )
                

Inventories—net

   $ 1,722     $ 2,002  
                

 

(a) Long-term portion of deferred costs is included in other assets.

 

8


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Other current assets:

     September 30,
2008
   December 31,
2007

Prepaid expenses

   $ 118    $ 152

Income taxes recoverable

     81      77

Current investments

     8      15

Other

     255      223
             

Other current assets

   $ 462    $ 467
             

Investments:

Investments include $83 and $101 as of September 30, 2008 and December 31, 2007, respectively, related to long-term investment assets held in an employee benefit trust in Canada, and restricted as to their use in operations by Nortel. In prior years, Nortel classified its auction rate securities as current assets. However, due to current financial market conditions, these investments have been reclassified as long-term investments. During the current year, Nortel reclassified $28 in auction rate securities as long-term investments, which after partial redemptions throughout the period has been reduced to $19 as of September 30, 2008. See note 12 for more information.

Plant and equipment—net:

     September 30,
2008
    December 31,
2007
 

Cost:

    

Land

   $ 37     $ 38  

Buildings

     1,097       1,137  

Machinery and equipment

     1,991       2,176  

Assets under capital lease

     196       215  

Sale lease-back assets

     95       97  
                
     3,416       3,663  
                

Less accumulated depreciation:

    

Buildings

     (411 )     (395 )

Machinery and equipment

     (1,478 )     (1,608 )

Assets under capital lease

     (99 )     (107 )

Sale lease-back assets

     (22 )     (21 )
                
     (2,010 )     (2,131 )
                

Plant and equipment—net(a)

   $ 1,406     $ 1,532  
                

 

(a) Includes assets held for sale with a carrying value of $64 and nil as of September 30, 2008 and December 31, 2007, respectively, related to owned facilities that are being actively marketed for sale.

Intangible assets—net:

     September 30,
2008
    December 31,
2007
 

Cost

   $ 311     $ 338  

Less: accumulated amortization

     (144 )     (125 )
                

Intangible assets—net

   $ 167     $ 213  
                

 

9


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Other assets:

 

     September 30,
2008
   December 31,
2007

Long-term deferred costs

   $ 163    $ 209

Long-term inventories

     25      27

Debt issuance costs

     64      62

Derivative assets

     71      77

Financial assets

     49      62

Other

     134      118
             

Other assets

   $ 506    $ 555
             

Other accrued liabilities:

 

     September 30,
2008
   December 31,
2007

Outsourcing and selling, general and administrative related provisions

   $ 241    $ 306

Customer deposits

     25      52

Product-related provisions

     89      126

Warranty provisions (note 11)

     198      214

Deferred revenue

     1,239      1,219

Advance billings in excess of revenues recognized to date on contracts(a)

     786      1,490

Miscellaneous taxes

     37      32

Income taxes payable

     80      96

Deferred income taxes

     19      15

Tax uncertainties (note 7)

     20      21

Interest payable

     69      91

Other

     66      163
             

Other accrued liabilities

   $ 2,869    $ 3,825
             

 

(a) Includes amounts that may be recognized beyond one year due to the duration of certain contracts.

Other liabilities:

 

     September 30,
2008
   December 31,
2007

Pension benefit liabilities

   $ 903    $ 1,109

Post-employment and post-retirement benefit liabilities

     860      893

Restructuring liabilities (note 6)

     162      180

Deferred revenue

     292      400

Tax uncertainties (note 7)

     77      71

Derivative liabilities

     36      33

Other long-term provisions

     166      189
             

Other liabilities

   $ 2,496    $ 2,875
             

 

10


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Condensed consolidated statements of cash flows

Change in operating assets and liabilities excluding Global Class Action Settlement (as defined in note 18)—net:

 

     Nine Months Ended
September 30,
 
         2008             2007      

Accounts receivable—net

   $ 632     $ 247  

Inventories—net

     (94 )     (60 )

Deferred costs

     386       104  

Income taxes

     —         2  

Accounts payable

     (137 )     (48 )

Payroll, accrued and contractual liabilities

     (435 )     (532 )

Deferred revenue

     (64 )     (181 )

Advance billings in excess of revenues recognized to date on contracts

     (704 )     109  

Restructuring liabilities

     21       23  

Other

     (196 )     (128 )
                

Change in operating assets and liabilities—excluding Global Class Action Settlement—net

   $ (591 )   $ (464 )
                

Acquisitions of investments and businesses—net of cash acquired:

 

     Nine Months Ended
September 30,
 
         2008             2007      

Cash acquired

   $ (2 )   $ —    

Total net assets acquired other than cash

     (110 )     (81 )
                

Total purchase price

     (112 )     (81 )

Less:

    

Cash acquired

     2       —    
                

Acquisitions of investments and businesses—net of cash acquired

   $ (110 )   $ (81 )
                

Interest and taxes paid:

 

     Nine Months Ended
September 30,
         2008            2007    

Cash interest paid

   $ 265    $ 328

Cash taxes paid

   $ 96    $ 77

 

11


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

4. Goodwill

The following table outlines goodwill by reportable segment:

 

     Enterprise
Solutions
    Carrier
Networks
    Metro
Ethernet
Networks
    Global
Services
    Other    Total  

Balance—as of December 31, 2007

   $ 484     $ 152     $ 660     $ 1,092     $ 171    $ 2,559  

Change:

             

Additions

     —         —         —         —         —        —    

Disposals

     —         —         —         —         —        —    

Foreign exchange

     (1 )     (1 )     (2 )     (4 )     —        (8 )

Other

     —         —         1       1       —        2  

Impairment

     (483 )     —         (659 )     —         —        (1,142 )
                                               

Balance—as of September 30, 2008

   $ —       $ 151     $ —       $ 1,089     $ 171    $ 1,411  
                                               

Goodwill Impairment Testing Policy

Nortel tests goodwill for possible impairment on an annual basis as of October 1 of each year and at any other time if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Circumstances that could trigger an impairment test between annual tests include, but are not limited to:

 

   

a significant adverse change in the business climate or legal factors;

 

   

an adverse action or assessment by a regulator;

 

   

unanticipated competition;

 

   

loss of key personnel;

 

   

the likelihood that a reporting unit or a significant portion of a reporting unit will be sold or disposed of;

 

   

a change in reportable segments;

 

   

results of testing for recoverability of a significant asset group within a reporting unit; and

 

   

recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.

The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to the reporting unit. Measurement of the fair value of a reporting unit is based on a fair value measure. Nortel determines the fair value of its reporting units using an income approach; specifically, based on discounted cash flows (“DCF Model”). A market approach is used as a reasonableness test, but not given any weighting in the final determination of fair value. These approaches involve significant management judgment and as a result are subject to change.

If the carrying amount of the reporting unit exceeds its fair value, step two requires the fair value of the reporting unit be allocated to the underlying assets and liabilities of that reporting unit, whether or not previously recognized, resulting in an implied fair value of goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss equal to the excess is recorded in net earnings (loss).

 

12


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

The fair value of each reporting unit is determined using discounted cash flows. A multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of each reporting unit is calculated and compared to market participants to corroborate the results of the calculated fair value (“EBITDA Multiple Model”). Nortel also reconciles the sum of the calculated fair values to its enterprise value, being market capitalization plus the estimated value of debt based on interest rates that would be applicable to purchasers (“Market Participants”), adjusted for other items as appropriate under U.S. GAAP. Such valuations involve significant assumptions regarding future operating performance. The following are the significant assumptions involved in each approach:

 

   

DCF Model: assumptions regarding revenue growth rates, gross margin percentages, projected working capital needs, selling, general and administrative (“SG&A”) expense, research and development (“R&D”) expense, capital expenditures, discount rates and terminal growth rates. To determine fair value, Nortel discounts the expected cash flows of each reporting unit. The discount rate Nortel uses represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in its reporting unit operations and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of its model, Nortel uses a terminal value approach. Under this approach, Nortel uses the estimated cash flows in the final year of its models and applies a perpetuity growth assumption and discount by a perpetuity discount factor to determine the terminal value. Nortel incorporates the present value of the resulting terminal value into its estimate of fair value.

 

   

EBITDA Multiple Model: estimates of EBITDA growth and the selection of comparable companies to determine an appropriate multiple.

Interim Goodwill Assessment

At September 30, 2008, in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”, Nortel concluded that events had occurred and circumstances had changed that required it to perform an interim period goodwill impairment test for its Enterprise Services (“ES”), Carrier Networks (“CN”), Metro Ethernet Services (“MEN”) and Global Services (“GS”) reporting units. In September 2008, in response to significant pressure resulting from the expanding economic downturn and the unfavorable impact of foreign exchange fluctuations, Nortel announced a revised full year 2008 outlook and estimated revenues to decline between two and four percent compared to 2007. Furthermore, during the quarter ended September 30, 2008, Nortel experienced a material decline in its market capitalization due primarily to the continued challenging market conditions, particularly in the U.S. The average closing price of Nortel Networks Corporation common shares (“NNC common shares”) on the New York Stock Exchange (“NYSE”) in the third quarter of 2008 was $5.77 compared to an average of $8.21 in the second quarter of 2008, a decline of approximately 30% and at September 30, 2008, Nortel’s market capitalization was less than its book value.

As part of its interim goodwill impairment test, Nortel updated its forecasted cash flows for each of its reporting units. This update considered current economic conditions and trends, estimated future operating results, Nortel’s view of growth rates and anticipated future economic conditions. Revenue growth rates inherent in this forecast are based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional trends in the telecommunications industry and product evolution from a technological segment basis. Macro economic factors such as changes in economies, product evolutions, industry consolidations and other changes beyond Nortel’s control could have a positive or negative impact on achieving its targets.

The results from step one of the two-step goodwill impairment test of each reporting unit indicated that the estimated fair values of the MEN and ES reporting units were less than the respective carrying values of their net assets and as such Nortel performed step two of the impairment test for these reporting units.

 

13


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

In step two of the impairment test, Nortel estimated the implied fair value of the goodwill of each of these reporting units and compared it to the carrying value of the goodwill for each of the MEN and ES reporting units. Specifically, Nortel allocated the fair value of the MEN and ES reporting units as determined in the first step to their respective recognized and unrecognized net assets, including allocations to identified intangible assets. The allocations of fair values of the MEN and ES reporting units also require Nortel to make significant estimates and assumptions, including those in determining the fair values of the identified intangible assets. Such intangible assets had fair values substantially in excess of current book values. The resulting implied goodwill for each of these reporting units was nil; accordingly Nortel reduced the goodwill recorded prior to the assessment by $1,142 to write down the goodwill related to MEN and ES to the implied goodwill amount as of September 30, 2008. The $1,142 goodwill impairment charge is Nortel’s best estimate of the goodwill charge as of September 30, 2008. Any adjustments to the estimated charge resulting from the completion of the measurement of the impairment loss will be recognized in the quarter and year ending December 31, 2008. The allocation discussed above is performed only for purposes of assessing goodwill for impairment; accordingly Nortel did not adjust the net book value of the assets and liabilities on its condensed consolidated balance sheet other than goodwill as a result of this process.

No impairment losses related to Nortel’s goodwill were recorded during the three and nine months ended September 30, 2007.

Related Analyses

In conjunction with Nortel’s assessment of goodwill for impairment, Nortel re-assessed the remaining useful lives of its long-lived assets and concluded they were appropriate. In addition, prior to the goodwill analysis discussed above, Nortel performed a recoverability test of the long-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Nortel included cash flow projections from operations along with cash flows associated with the eventual disposition of the long-lived assets, where appropriate. The undiscounted future cash flows of the long-lived assets exceeded their net book value and, as a result, no impairment charge was recorded.

 

5. Segment information

Segment descriptions

Nortel’s operations are organized around four reportable segments consisting of CN, ES, GS and MEN. The segments are described below.

 

   

CN provides mobility networking solutions using (i) Code Division Multiple Access (“CDMA”), Global System for Mobile Communication (“GSM”) and Universal Mobile Telecommunication System (“UMTS”) radio access technologies and fixed and mobile networking solutions using Worldwide Interoperability for Microwave Access (“WiMAX”) radio access technology; and (ii) carrier circuit and packet voice solutions. Mobility networking refers to communications networks that enable end users to be mobile while they send and receive voice and data communications using wireless devices such as cellular telephones, personal digital assistants, laptops and other computing and communications devices. These networks use specialized network access equipment and specialized core networking equipment that enable an end user to be connected and identified when not in a fixed location and to roam globally. In addition, Nortel’s carrier circuit and packet voice solutions provide a broad range of voice solutions to its service provider customers for business and residential subscribers, traditional, full featured voice services as well as internet-based voice and multimedia communications services using either circuit or packet-based switching technologies. These service provider customers include local and long distance telephone companies, wireless service providers, cable operators and other communication service providers. Increasingly, CN addresses customers who want to provide services across both wireless as well as wired devices.

 

14


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

   

ES provides Unified Communications (“UC”) solutions to enterprise customers using: (i) Business Optimized Communications; and (ii) Business Optimized Networking. Business Optimized Communications is comprised of enterprise circuit and packet voice solutions, software solutions for multi-media messaging, conferencing and contact centers and Service Oriented Architecture based communications enabled applications. Business Optimized Networking solutions are inclusive of data networking, wireless LAN, data centers and security. Nortel’s UC solutions transform an enterprise’s existing communications to deliver a unified, real time, multi-media experience including voice, video, email and instant messaging. Nortel’s ES customers consist of a broad range of enterprises around the world, including large businesses at their headquarters, data centers, call centers and branch offices, small and medium-size businesses and home offices, as well as government agencies, educational and other institutions and utility organizations.

 

   

GS provides a broad range of services to address the requirements of Nortel’s carrier and enterprise customers throughout the entire lifecycle of their networks. The GS portfolio is organized into four main service product groups: (i) network implementation services, including network integration, planning, installation, optimization and security services; (ii) network support services, including technical support, hardware maintenance, equipment spares logistics and on-site engineers; (iii) network managed services, including services related to the monitoring and management of customer networks and providing a range of network managed services/hosted solutions options; and (iv) network application services, including applications development, integration and communications-enabled application solutions. Nortel’s GS market mirrors that of its carrier and enterprise markets along with a broad range of customers in all geographic regions where Nortel conducts business, including wireline and wireless carriers, cable operators, small and medium-size businesses, large global enterprises and all levels of government.

 

   

MEN combines Nortel’s optical networking solutions and the carrier portion of its data networking solutions to transform its carrier and large enterprise customers’ networks to be more scalable and reliable for the high speed delivery of diverse multi-media communications services. By combining Nortel’s optical expertise and data knowledge, Nortel creates carrier Ethernet solutions that help service providers and enterprises better manage increasing bandwidth demands. Nortel differentiates its MEN solutions by using technology innovations such as Provider Backbone Bridges, Provider Backbone Transport and 40G Dual Polarization Quadrature Phase Shift Keying to deliver increased network capacity at lower cost per bit and with a simpler operations paradigm. Both metropolitan, or metro, and long-haul networks are key focus areas as bandwidth demands are increasing as a result of the growth of network-based broadcast and on-demand video delivery, wireless “backhaul” for a variety of data services including video, as well as traditional business, internet and private line and voice services.

 

   

Other miscellaneous business activities and corporate functions, including the operating results of Nortel Government Solutions Incorporated, do not meet the quantitative criteria to be disclosed separately as reportable segments and have been reported in “Other”. Costs associated with shared services, such as general corporate functions, that are managed on a common basis are allocated to Nortel’s reportable segments based on usage determined generally by headcount. A portion of other general and miscellaneous corporate costs and expenses are allocated based on a fixed charge established annually. Costs not allocated to the reportable segments include employee share-based compensation, differences between actual and budgeted employee benefit costs, interest attributable to Nortel’s long-term debt and other non-operational activities, and are included in “Other”.

Nortel’s president and chief executive officer (the “CEO”) has been identified as the Chief Operating Decision Maker in assessing segment performance and in deciding how to allocate resources to the segments. The primary

 

15


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

financial measure used by the CEO in assessing performance and allocating resources to the segments is Management Operating Margin (“Management OM”). Management OM was previously referred to in Nortel’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 filed with the SEC and Canadian securities regulatory authorities, as Operating Margin. Management OM is defined by Nortel as follows: total revenues less total cost of revenues, SG&A and R&D expense. Previously, the CEO used management earnings (loss) before income taxes (“Management EBT”). Management EBT was a measure that included total revenues, total cost of revenues, SG&A and R&D expense, interest expense, other operating expense (income)—net, other income (expense)—net, and minority interests—net of tax and equity in net earnings (loss) of associated companies—net of tax. Comparative information from the periods prior to March 31, 2008 has been restated to conform to the current presentation as a result of the new primary financial measure used by the CEO. The accounting policies of the reportable segments are the same as those applied to the condensed consolidated financial statements. The CEO does not review asset information on a segmented basis in order to assess performance and allocate resources.

 

16


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Segments

The following tables set forth information by segment for the following periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2008             2007             2008             2007      

Revenues

        

Carrier Networks

   $ 822     $ 1,080     $ 3,078     $ 3,147  

Enterprise Solutions

     616       671       1,867       1,858  

Global Services

     507       540       1,559       1,482  

Metro Ethernet Networks

     317       360       1,022       1,096  
                                

Total reportable segments

     2,262       2,651       7,526       7,583  

Other

     57       54       173       167  
                                

Total revenues

   $ 2,319     $ 2,705     $ 7,699     $ 7,750  
                                

Management Operating Margin

        

Carrier Networks

   $ 80     $ 169     $ 523     $ 498  

Enterprise Solutions

     (5 )     11       (50 )     (7 )

Global Services

     59       105       214       255  

Metro Ethernet Networks

     (18 )     2       (26 )     (8 )
                                

Total reportable segments

     116       287       661       738  

Other

     (99 )     (153 )     (401 )     (581 )
                                

Total Management Operating Margin

     17       134       260       157  

Amortization of intangible assets

     11       12       34       37  

Special charges

     50       56       205       172  

Loss (gain) on sales of businesses and assets

     (6 )     3       (10 )     (8 )

Shareholder litigation settlement recovery

     —         —         —         (54 )

Regulatory investigation expense

     —         —         —         35  

Goodwill impairment

     1,142       —         1,142       —    

Other operating expense (income)—net

     8       (7 )     14       (29 )
                                

Operating earnings (loss)

     (1,188 )     70       (1,125 )     4  

Other income (expense)—net

     (21 )     95       (19 )     156  

Interest and dividend income

     27       61       95       176  

Interest expense

     (81 )     (107 )     (237 )     (301 )

Income tax expense

     (2,129 )     (50 )     (2,226 )     (74 )

Minority interests—net of tax

     (21 )     (43 )     (154 )     (76 )

Equity in net earnings of associated companies—net of tax

     —         1       2       2  
                                

Net earnings (loss)

   $ (3,413 )   $ 27     $ (3,664 )   $ (113 )
                                

Nortel had no customer that generated more than 10% of total consolidated revenues for the three months ended September 30, 2008 although one customer generated revenues of approximately $790 or 10% of total consolidated revenues for the nine months ended September 30, 2008. The revenues were generated throughout all of Nortel’s reportable segments. For the three and nine months ended September 30, 2007, Nortel had one customer that generated revenues of approximately $275 and $854 or 10% and 11%, respectively, of total consolidated revenues.

 

17


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

6. Special charges

On February 27, 2008, as part of its further efforts to increase competitiveness by improving profitability and overall business performance, Nortel announced a restructuring plan that included net workforce reductions of approximately 2,100 positions and shifting approximately 1,000 additional positions from higher-cost to lower-cost locations, resulting in gross workforce reductions of approximately 3,100. Subsequently, expected workforce reductions were reduced by 370 as a result of changes in organizational strategy resulting in revised gross workforce reductions of approximately 2,700. Further, as a result of decreased R&D spending and continued cost reduction initiatives, Nortel revised the estimated number of lower-cost location hires to approximately 500. As a result of these adjustments, net workforce reductions are expected to be approximately 2,200. The reductions will occur through both voluntary attrition and involuntary terminations. In addition to the workforce reductions, Nortel announced steps to achieve additional cost savings by efficiently managing its various business locations and further consolidating real estate requirements. Collectively, these efforts are referred to as the “2008 Restructuring Plan”. Nortel originally expected total charges to earnings and cash outlays related to workforce reductions to be approximately $205. Nortel now expects charges to earnings and cash outlays for workforce reductions to be approximately $185 as a result of higher than expected attrition and redeployment and reduced workforce reductions which amount is expected to be substantially incurred over fiscal 2008 and 2009. Nortel originally expected total charges to earnings related to the consolidation of real estate to be approximately $70, including approximately $25 related to fixed asset writedowns, to be incurred over fiscal 2008 and 2009, and cash outlays of approximately $45 to be incurred through 2024. Nortel now expects total charges to earnings related to the consolidation of real estate to be approximately $60, including a revised amount of approximately $15 related to fixed asset writedowns, to be substantially incurred over fiscal 2008 and 2009. Related cash outlays are expected to remain unchanged. Approximately $130 of the total charges relating to the 2008 Restructuring Plan have been incurred during the nine months ended September 30, 2008. Approximately 70% of the total restructuring expense related to the 2008 Restructuring Plan is expected to be incurred by the end of 2008.

During the first quarter of 2007, as part of its continuing efforts to increase competitiveness by improving profitability and overall business performance, Nortel announced a restructuring plan that included net workforce reductions of approximately 2,900 positions and shifting approximately 1,000 additional positions from higher-cost to lower-cost locations, resulting in gross workforce reductions of approximately 3,900. During the year ended December 31, 2007, approximately 150 additional reductions were identified and incorporated into the plan with associated costs of approximately $15 and a revision of approximately 300 fewer position reductions with associated costs of approximately $18 was made as a result of a change in strategy regarding shared services. During the current quarter, workforce reductions were further reduced by approximately 200 as a result of changes in organizational strategy. As a result, Nortel currently expects the gross workforce reductions to be approximately 3,550. Further, as a result of decreased R&D spending and continued cost reduction initiatives, Nortel revised the estimated number of higher to lower-cost location hires to approximately 400. As a result of these further adjustments, net workforce reductions are now expected to be approximately 3,150. The reductions will occur through both voluntary attrition and involuntary terminations. In addition to the workforce reductions, Nortel announced steps to achieve additional cost savings by efficiently managing its various business locations and consolidating real estate requirements. Collectively, these efforts are referred to as the “2007 Restructuring Plan”. Nortel originally expected total charges to earnings and cash outlays for the 2007 Restructuring Plan to be approximately $340 and $320, respectively, and expected that workforce reductions and shifting of positions would account for $260 of the estimated expense, and $80 would relate to real estate consolidations. As of September 30, 2008, Nortel expects total charges to earnings and cash outlays for the 2007 Restructuring Plan to be approximately $280 and $260, respectively. Nortel now expects that workforce reductions and shifting of positions will account for $200 of the estimated expense as a result of the reduced workforce reductions, and $80

will relate to real estate consolidation. The workforce reductions are expected to be completed by the end of 2008

 

18


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

and the charges for ongoing lease costs are to be incurred by the end of 2009 with the related cash outlay to be incurred by the end of 2024. Approximately $238 of the total charges relating to the 2007 Restructuring Plan have been incurred as of September 30, 2008.

During the second quarter of 2006, in an effort to increase competitiveness by improving profitability and overall business performance, Nortel announced a restructuring plan that included workforce reductions of approximately 1,900 positions (the “2006 Restructuring Plan”). The workforce reductions occurred primarily in the U.S. and Canada and spanned all of Nortel’s segments. Nortel originally estimated the total charges to earnings and cash outlays associated with the 2006 Restructuring Plan to be approximately $100. During 2007, the program was determined to be substantially complete resulting in a total reduction of 1,750 positions with a revised total cost of approximately $85. The cost revisions were primarily due to higher voluntary attrition reducing the number of involuntary actions requiring the payment of benefits.

During 2004 and 2001, Nortel implemented work plans to streamline operations through workforce reductions and real estate optimization strategies (the “2004 Restructuring Plan” and the “2001 Restructuring Plan”). All of the charges with respect to the workforce reductions have been incurred and the remainder of the charges for ongoing lease costs are to be substantially incurred by the end of 2016 for the 2004 Restructuring Plan and the end of 2013 for the 2001 Restructuring Plan.

 

19


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

During the nine months ended September 30, 2008, Nortel continued to implement these restructuring plans. Special charges were as follows:

 

                            Special charges  
    Workforce
reduction
    Contract
settlement
and lease
costs
    Plant and
equipment
write downs
    Total     Three Months
Ended
September 30,
2008
  Nine Months
Ended
September 30,
2008
 

2008 Restructuring Plan

           

Provision balance as of December 31, 2007

  $ —       $ —       $ —       $ —        

Other special charges

    118       6       8       132     $ 26   $ 132  

Revisions to prior accruals

    (4 )     2       —         (2 )     1     (2 )

Cash drawdowns

    (50 )     (3 )     —         (53 )    

Non-cash drawdowns

    —         —         (8 )     (8 )    

Foreign exchange and other adjustments

    (3 )     (1 )     —         (4 )    
                                   

Provision balance as of September 30, 2008

  $ 61     $ 4     $ —       $ 65      
                                   

2007 Restructuring Plan

           

Provision balance as of December 31, 2007

  $ 43     $ 25     $ —       $ 68      

Other special charges

    44       15       2       61     $ 16   $ 61  

Revisions to prior accruals

    (1 )     7       —         6       3     6  

Cash drawdowns

    (61 )     (15 )     —         (76 )    

Non-cash drawdowns

    (1 )     (3 )     (2 )     (6 )    

Foreign exchange and other adjustments

    (1 )     —         —         (1 )    
                                   

Provision balance as of September 30, 2008

  $ 23     $ 29     $ —       $ 52      
                                   

2006 Restructuring Plan

           

Provision balance as of December 31, 2007

  $ 8     $ —       $ —       $ 8      

Other special charges

    —         —         —         —       $ —     $ —    

Revisions to prior accruals

    (1 )     —         —         (1 )     —       (1 )

Cash drawdowns

    (7 )     —         —         (7 )    

Non-cash drawdowns

    —         —         —         —        

Foreign exchange and other adjustments

    —         —         —         —        
                                   

Provision balance as of September 30, 2008

  $ —       $ —       $ —       $ —        
                                   

2004 Restructuring Plan

           

Provision balance as of December 31, 2007

  $ —       $ 51     $ —       $ 51      

Other special charges

    —         1       —         1     $ —     $ 1  

Revisions to prior accruals

    —         7       —         7       3     7  

Cash drawdowns

    —         (11 )     —         (11 )    

Non-cash drawdowns

    —         (1 )     —         (1 )    

Foreign exchange and other adjustments

    —         (3 )     —         (3 )    
                                   

Provision balance as of September 30, 2008

  $ —       $ 44     $ —       $ 44      
                                   

2001 Restructuring Plan

           

Provision balance as of December 31, 2007

  $ —       $ 153     $ —       $ 153      

Other special charges

    —         —         —         —       $ —     $ —    

Revisions to prior accruals

    —         1       —         1       1     1  

Cash drawdowns

    —         (25 )     —         (25 )    

Non-cash drawdowns

    —         (6 )     —         (6 )    

Foreign exchange and other adjustments

    —         (5 )     —         (5 )    
                                   

Provision balance as of September 30, 2008

  $ —       $ 118     $ —       $ 118      
                                   

Total provision balance as of September 30,
2008
(a)

  $ 84     $ 195     $ —       $ 279      
                                             

Total special charges

          $ 50   $ 205  
                     

 

(a) As of September 30, 2008 and December 31, 2007, the short-term provision balances were $117 and $100, respectively, and the long-term provision balances were $162 and $180, respectively.

 

20


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

2008 Restructuring Plan

Three and nine months ended September 30, 2008

For the three and nine months ended September 30, 2008, Nortel recorded special charges of $25 and $114, respectively, related to severance and benefit costs associated with an involuntary workforce reduction of approximately 1,350 employees, of which approximately 400 and 1,000 were notified of termination during the three and nine months ended September 30, 2008, respectively. The workforce reduction was primarily in the U.S. and Canada and extended across all of Nortel’s segments, with the majority of the reductions occurring in the ES and CN business segments.

2007 Restructuring Plan

Three and nine months ended September 30, 2008

For the three and nine months ended September 30, 2008, Nortel recorded special charges of $13 and $43, respectively, related to severance and benefit costs with respect to the 2007 Restructuring Plan. The involuntary workforce reduction to date has been approximately 1,950 employees, of which approximately 190 and 600 were notified of termination during the three and nine months ended September 30, 2008, respectively. This portion of the workforce reduction was primarily in the U.S. and Canada, with other reductions being incurred in Europe, the Middle East and Africa (“EMEA”). Nortel recorded contract settlement and lease costs of $4 and $22 including revisions of $3 and $7 during the three and nine months ended September 30, 2008, respectively. Cash expenditures related to contract settlement and lease costs of $5 and $15 were incurred during the three and nine months ended September 30, 2008, respectively. For the 2007 Restructuring Plan, the remaining contract settlement and lease costs provision, which is net of approximately $37 in estimated sublease income, is expected to be substantially drawn down by the end of 2016. To date Nortel has incurred approximately 85% of the total restructuring expense related to the 2007 Restructuring Plan.

2006 Restructuring Plan

Three and nine months ended September 30, 2008

Nortel incurred total cash costs related to the 2006 Restructuring Plan of approximately nil and $7 during the three and nine months ended September 30, 2008, respectively. The provision balance for the 2006 Restructuring Plan was drawn down to nil during the nine months ended September 30, 2008.

2004 Restructuring Plan

Three and nine months ended September 30, 2008

The provision balance for contract settlement and lease costs remaining for the 2004 Restructuring Plan was drawn down by cash payments of $4 and $11 during the three and nine months ended September 30, 2008, respectively. The remaining 2004 Restructuring Plan provision, which is net of approximately $34 in estimated sublease income, is expected to be substantially drawn down by the end of 2016.

2001 Restructuring Plan

Three and nine months ended September 30, 2008

The provision balance for contract settlement and lease costs was drawn down by cash payments of $9 and $25 during the three and nine months ended September 30, 2008, respectively. The remaining provision, net of

 

21


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

approximately $123 in estimated sublease income, is expected to be substantially drawn down by the end of 2013.

Segments

The following table summarizes the total special charges incurred for each of Nortel’s restructuring plans by segment during the following periods:

 

     Enterprise
Solutions
   Carrier
Networks
    Metro
Ethernet
Networks
   Global
Services
   Total  

2008 Restructuring Plan

   $ 7    $ 12     $ 4    $ 4    $ 27  

2007 Restructuring Plan

     2      15       1      1      19  

2006 Restructuring Plan

     —        —         —        —        —    

2004 Restructuring Plan

     1      1       1      —        3  

2001 Restructuring Plan

     —        1       —        —        1  
                                     

Total special charges for the three months ended September 30, 2008

   $ 10    $ 29     $ 6    $ 5    $ 50  
                                     

2008 Restructuring Plan

   $ 44    $ 47     $ 19    $ 20    $ 130  

2007 Restructuring Plan

     6      49       10      2      67  

2006 Restructuring Plan

     —        (1 )     —        —        (1 )

2004 Restructuring Plan

     2      3       2      1      8  

2001 Restructuring Plan

     —        1       —        —        1  
                                     

Total special charges for the nine months ended September 30, 2008

   $ 52    $ 99     $ 31    $ 23    $ 205  
                                     

2007 Restructuring Plan

   $ 5    $ 20     $ 4    $ 7    $ 36  

2006 Restructuring Plan

     2      3       1      7      13  

2004 Restructuring Plan

     1      2       —        —        3  

2001 Restructuring Plan

     1      3       —        —        4  
                                     

Total special charges for the three months ended September 30, 2007

   $ 9    $ 28     $ 5    $ 14    $ 56  
                                     

2007 Restructuring Plan

   $ 22    $ 86     $ 24    $ 12    $ 144  

2006 Restructuring Plan

     3      6       2      7      18  

2004 Restructuring Plan

     2      3       —        —        5  

2001 Restructuring Plan

     1      4       —        —        5  
                                     

Total special charges for the nine months ended September 30, 2007

   $ 28    $ 99     $ 26    $ 19    $ 172  
                                     

As described in note 5, Management OM by segment does not include special charges. A significant portion of Nortel’s provisions for workforce reductions and contract settlement and lease costs are associated with shared services. These costs have been allocated to the segments in the table above, based generally on headcount, SG&A allocations and revenue streams. Prior to 2008, Nortel allocated these costs only based on headcount and revenue streams.

 

7. Income taxes

During the nine months ended September 30, 2008, Nortel recorded a tax expense of $2,226 on loss from operations before income taxes, minority interests and equity in net earnings of associated companies of $1,286.

 

22


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Included in the loss from operations before income taxes is an impairment related to goodwill in the amount of $1,142 that impacted Nortel’s effective tax rate for the three and nine months ended September 30, 2008. The tax expense of $2,226 is largely comprised of several significant items, including $1,103 relating to the establishment of a full valuation allowance against Nortel’s net deferred tax asset in Canada, and $816 and $150 relating to increases in the valuation allowance against the deferred tax assets in the U.S. and the United Kingdom (“U.K.”), respectively. Also included in income tax expense is $103 of income taxes on profitable entities in Asia and Europe that includes a $6 valuation allowance release in Germany based on earnings, $34 of income taxes resulting from revisions to prior year tax estimates, $20 from increases in uncertain tax positions and other taxes of $22, primarily related to taxes on preferred share dividends in Canada. This tax expense was partially offset by a $22 benefit derived from various tax credits and R&D-related incentives.

During the third quarter of 2008, the expanding global economic downturn has had a negative effect on, and created uncertainty around our near-term modeled forecasts of taxable income. While Nortel’s mid- to long-term financial outlook remains positive, significant uncertainty about the global economy during the third quarter of 2008 led Nortel to revise downward its near-term modeled forecasts. To realize the deferred tax assets in its significant tax jurisdictions, these revisions resulted in a need to rely on an increased proportion of future taxable income generated by later years and an extended forecasting period, to a greater extent in Canada and to a lesser extent in the U.S. and the U.K. However, by their nature, modeled forecasted results become less objective and verifiable the further away they are from the current year. Accordingly, Nortel decided that it needed to shorten the timeframe on which it relies for these modeled forecasts and increased its valuation allowance by $2,069 as of September 30, 2008, as it no longer believes that it can meet the criteria to conclude that the related tax benefit is more likely than not to be realized.

During the nine months ended September 30, 2007, Nortel recorded a tax expense of $74 on earnings from operations before income taxes, minority interests and equity in net earnings of associated companies of $35. The tax expense of $74 is largely comprised of $67 of income taxes on profitable entities in Asia and Europe, including a reduction of Nortel’s deferred tax assets in EMEA, $33 of income taxes relating to tax rate reductions enacted during the first nine months of 2007 in EMEA and Asia, and other taxes of $12 primarily related to tax on preferred share dividends in Canada. This tax expense was partially offset by a $22 benefit derived from various tax credits, primarily R&D-related incentives, and a $14 benefit in EMEA as a result of transfer pricing adjustments.

As of September 30, 2008, Nortel’s net deferred tax assets were $1,085 resulting from net operating loss carryforwards, tax credit carryforwards and temporary differences between the financial reporting and tax treatment of certain current assets and liabilities and non-current assets and liabilities.

In accordance with the FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,” (“FIN 48”), Nortel recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Nortel adopted FIN 48 effective January 1, 2007.

Based on the application of the provisions of FIN 48, Nortel had approximately $1,743 and $1,329 of total gross unrecognized tax benefits as of September 30, 2008 and December 31, 2007 respectively. As of September 30, 2008, of the total gross unrecognized tax benefits, $61 represented the amount of unrecognized tax benefits that would favorably affect the effective income tax rate in future periods, if recognized. The net change of $414 since December 31, 2007 consists of an increase of $39 for new uncertain tax positions arising in 2008, an

 

23


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

increase of $445 arising from uncertain tax positions taken during prior periods, offset by a decrease of $2 resulting from settlements of uncertain tax positions and a decrease of $68 resulting from changes to the measurement of existing uncertain tax positions for changes to foreign exchange rates and other measurement criteria.

Included in the $445 of uncertain tax positions taken during prior periods is an increase of $346 to reflect a decrease in the deferred tax assets in the U.S. for adjustments related to transfer pricing in the 2001 to 2005 taxation years and an increase of $76 related to transfer pricing adjustments in the 2006 and 2007 taxation years, mainly in the U.S., U.K. and France. This is offset by a decrease of $8 related to the reduction of an uncertain tax position in Colombia which has favorably impacted the effective tax rate for 2008.

Nortel recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the first nine months ended September 30, 2008, Nortel recognized approximately $13 in interest, penalties and foreign exchange translation, partially offset by a decrease of $9 resulting from the decrease in the uncertain tax position in Colombia. Nortel had accrued approximately $36 and $32 for the payment of interest and penalties as of September 30, 2008 and December 31, 2007, respectively.

Nortel believes it is reasonably possible that $653 of its gross unrecognized tax benefit will decrease during the twelve months ending September 30, 2009 with such amount attributable to possible decreases of $548 from the potential resolution of Nortel’s ongoing Advance Pricing Arrangements (“APA”) negotiations, $84 will result from including unrecognized tax benefits on amended income tax returns, and $21 will result from the potential settlement of audit exposures in South America, Asia and Europe. If achieved, it is anticipated that $19 of these potential decreases in unrecognized tax benefits would impact Nortel’s effective tax rate.

Nortel is subject to tax examinations in all major taxing jurisdictions in which it operates and currently has examinations open in Canada, the U.S., France, Australia, Germany and Brazil. In addition, Nortel has ongoing audits in other smaller jurisdictions including, but not limited to, Italy, Poland, Colombia and India. Nortel’s 2000 through 2007 tax years remain open in most of these jurisdictions primarily as a result of ongoing negotiations regarding APAs affecting these periods.

Nortel regularly assesses the status of tax examinations and the potential for adverse outcomes to determine the adequacy of the provision for income and other taxes. Specifically, the tax authorities in Brazil have completed an examination of prior taxation years and have issued assessments in the aggregate amount of $78 for the taxation years 1999 and 2000. In addition, the tax authorities in France issued assessments in respect of the 2001, 2002 and 2003 taxation years. These assessments collectively propose adjustments to increase taxable income of approximately $1,327, additional income tax liabilities of $52 inclusive of interest, as well as certain increases to withholding and other taxes of approximately $106 plus applicable interest and penalties. Nortel withdrew from discussions at the tax auditor level during the first quarter of 2007 and has entered into Mutual Agreement Procedures (“MAP”) with the competent authority under the Canada-France tax treaty to settle the dispute and avoid double taxation. Nortel believes that it has adequately provided for tax adjustments that are more likely than not to be realized as a result of any ongoing or future examinations.

Nortel had previously entered into APAs with the taxation authorities of the U.S. and Canada in connection with its inter-company transfer pricing and cost sharing arrangements between Canada and the U.S. These arrangements expired in 1999 and 2000. In 2002, Nortel filed APA requests with the taxation authorities in the U.S., Canada and the U.K. that applied to the taxation years 2001 through 2005. The APA requests are currently under consideration and the tax authorities are in the process of negotiating the terms of the arrangement. In September 2008, the Canadian tax authorities provided the U.S. tax authorities with a supplemental position

 

24


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

paper regarding the 2001-2005 APA under negotiation. The proposal suggests a material reallocation of losses from the U.S. to Canada. Nortel has not received any indication from the U.S. tax authorities on their views of the supplemental position. Nortel continues to monitor the progress of these negotiations; however, it is not a party to the government-to-government negotiations. It is possible that the ultimate resolution to the negotiations could be a further reallocation of losses from the U.S. to Canada. Nortel has applied the transfer pricing methodology proposed in the APA requests to the parties subject to the transfer pricing methodology in preparing its tax returns and accounts from 2001 through 2005. The parties are the U.S., Canada, U.K., France, Ireland and Australia.

The ultimate outcome of the APA is uncertain and ultimate reallocation of losses as they relate to the APA negotiations cannot be determined at this time. There could be a further material shift in historical earnings between the above mentioned parties, particularly the U.S. and Canada. If this matter is resolved unfavorably, it could have a material adverse effect on Nortel’s consolidated financial position, results of operations or cash flows. However, Nortel believes it is more likely than not that the ultimate resolution of these negotiations will not have a material adverse effect on its consolidated financial position, results of operations or cash flows.

Nortel is in the process of negotiating new bilateral APA requests for tax years 2007 through at least 2010, with a request for rollback to 2006 in the U.S. and Canada, following methods generally similar to those under negotiation for 2001 through 2005. While preparing the new bilateral APA request, Nortel made some adjustments to the economics of the transfer pricing methodology (“TPM”). The tax filings for 2006 will be amended to reflect the adjustments to the new TPM and, with the exception of Nortel Networks Limited (“NNL”), the tax filings for 2007 will include the adjustments to the TPM. The adjustments resulted in decreases to deferred tax assets in the U.K. of $4 and $4 for 2006 and 2007, respectively. In other jurisdictions, changes resulting from adjustments to the new TPM impacted the level of deferred tax assets with an offset to valuation allowance and no impact to tax expense.

 

8. Employee benefit plans

Nortel maintains various retirement programs covering substantially all of its employees, consisting of defined benefit, defined contribution and investment plans.

Nortel has multiple capital accumulation and retirement programs including: defined contribution and investment programs available to substantially all of its North American employees; the flexible benefits plan, which includes a group personal pension plan, available to substantially all of its employees in the U.K.; and traditional defined benefit programs that are closed to new entrants. Although these programs represent Nortel’s major retirement programs and may be available to employees in combination and/or as options within a program, Nortel also has smaller pension plan arrangements in other countries.

Nortel also provides other benefits, including post-retirement benefits and post-employment benefits. Employees previously enrolled in the capital accumulation and retirement programs offering post-retirement benefits are eligible for company sponsored post-retirement health care and/or death benefits, depending on age and/or years of service. Substantially all other employees have access to post-retirement benefits by purchasing a Nortel-sponsored retiree health care plan at their own cost.

Nortel’s policy is to fund defined benefit pension and other post-retirement and post-employment benefits based on accepted actuarial methods as permitted by regulatory authorities. The funded amounts reflect actuarial assumptions regarding compensation, interest and other projections. Pension and other post-retirement and post-employment benefit costs reflected in the condensed consolidated statements of operations are based on the

 

25


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

projected benefit method of valuation. A measurement date of September 30 has historically been used annually to determine pension and other post-retirement benefit measurements for the pension plans and other post- retirement benefit plans that make up the majority of plan assets and obligations. Beginning in 2008, a measurement date of December 31 will be used for all plans in accordance with the guidance in SFAS 158. Under the transition approach selected by Nortel, the measurements determined for the 2007 fiscal year end reporting were used to estimate the effects of the change. Net periodic benefit cost for the period between the 2007 measurement date and the end of 2008 were allocated proportionately between amounts to be recognized as an adjustment of retained earnings and net periodic benefit cost for 2008. This adoption has had the effect of increasing accumulated deficit by $33, net of taxes, and increasing accumulated other comprehensive income by $5, net of taxes, as of January 1, 2008.

The following details the net pension expense for the defined benefit plans for the following periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2008             2007             2008             2007      

Pension expense:

        

Service cost

   $ 7     $ 28     $ 32     $ 88  

Interest cost

     123       121       380       354  

Expected return on plan assets

     (131 )     (127 )     (400 )     (373 )

Amortization of prior service cost

     1       1       3       3  

Amortization of net losses

     9       27       28       79  

Curtailment, contractual and special termination losses

     1       —         4       2  
                                

Net pension expense

   $ 10     $ 50     $ 47     $ 153  
                                

The following details the net cost components of post-retirement benefits other than pensions for the following periods:

 

     Three months ended
September 30,
    Nine Months Ended
September 30,
 
         2008             2007             2008             2007      

Post-retirement benefits cost:

        

Service cost

   $ 1     $ 1     $ 3     $ 3  

Interest cost

     10       10       31       27  

Amortization of prior service cost

     (3 )     (6 )     (8 )     (10 )

Amortization of net losses

     —         (1 )     —         (1 )
                                

Net post-retirement benefits cost

   $ 8     $ 4     $ 26     $ 19  
                                

During the nine months ended September 30, 2008 and 2007, contributions of $211 and $272, respectively, were made to the defined benefit plans and $31 and $27, respectively, to the post-retirement benefit plans. Nortel expects to contribute an additional $64 in 2008 to the defined benefit pension plans for a total contribution of $275, and an additional $12 in 2008 to the post-retirement benefit plans for a total contribution of $43.

 

26


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

9. Acquisitions and divestitures

Acquisition

Other Acquisitions

The following table sets out certain information for the acquisitions completed by Nortel during the three months ended September 30, 2008. All of these acquisitions were accounted for using the purchase method. The unaudited consolidated financial statements include the operating results of each of these businesses as of their respective dates of acquisition.

 

Acquisition

   Closing Date    Purchase
Price
   Goodwill    Acquired
Technology
   Other
Intangibles
   Net
Tangible
Assets
(Liabilities)

Novera Optics, Inc.(a)

   01-Aug-08    $ 18    $ —      $ 15    $ —      $ 3

Pingtel Corp.(b)

   08-Aug-08      6      —        6      —        —  

Diamondware Ltd.(c)

   19-Aug-08      5      —        3      2      —  

LG Electronics Inc. (“LGE”)—Wireless Local Loop(d)

   08-Aug-08      3      —        —        2      1

 

(a) On August 1, 2008, LG—Nortel acquired 100% of the issued and outstanding stock of Novera Optics Korea Inc. and Novera Optics, Inc. (“Novera”) for $18, plus up to an additional $10 based on achievement of business milestones. Novera was a privately-held company specializing in fiber-optic access solutions that extend high-speed carrier Ethernet services from optical core networks to customer premises.
(b) On August 8, 2008, Nortel purchased substantially all of the assets and certain liabilities of Pingtel Corp. (“Pingtel”) from Bluesocket Inc. (“Bluesocket”) for $4 in cash, and up to $4 based on the achievement of future business milestones plus the return of Nortel’s existing equity interest in Bluesocket which had been acquired for $2. Pingtel, a software-based unified communication solutions designer, was a wholly owned subsidiary of Bluesocket.
(c) On August 19, 2008, Nortel acquired 100% of the issued and outstanding stock of Diamondware, Ltd. (“Diamondware”) for $5 in cash and up to $3 based on achievement of future business milestones. Diamondware was a privately-held company, specializing in high-definition, proximity-based 3D positional voice technology.
(d) On August 8, 2008, LG-Nortel purchased certain assets and liabilities of LGE’s Wireless Local Loop (“WLL”) business for $3. The WLL products include fixed wireless terminals over CDMA and GSM licensed cellular networks.

The allocation of each purchase price is based on management’s current best estimate of the fair values of the assets acquired and liabilities assumed. However, because a full valuation of those assets and liabilities has not been finalized, the final allocation of each purchase price may differ from the current allocation disclosed.

LG-Nortel Co. Ltd. business venture

On November 3, 2005, NNL entered into a business venture with LGE, named LG-Nortel. Certain assets of Nortel’s South Korean distribution and services business were combined with the service business and certain assets of LGE’s telecommunications infrastructure business. In exchange for a cash contribution of $155 paid to LGE, NNL received 50% plus one share of the equity in LG-Nortel. LGE received 50% less one share of the equity in the business venture. Separately, LGE was entitled to payments from NNL over a two-year period based on the achievement by LG-Nortel of certain business goals in the 2006 and 2007 fiscal years, up to a maximum of $80. NNL and LGE agreed that the payment related to the 2006 fiscal year was $29 and this amount was recognized and paid in 2007. NNL recognized its remaining obligation of $51 in 2007 and paid it in the third quarter of 2008. As of December 31, 2007, this resulted in additional goodwill of $18.

 

27


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

10. Long-term debt

Senior notes offering

On May 28, 2008, NNL completed an offering of $675 aggregate principal amount of senior notes (the “2016 Fixed Rate Notes issued May 2008”) in the U.S. to qualified institutional buyers pursuant to Rule 144A under the U.S. Securities Act of 1933, as amended (the “Securities Act”), to persons outside the U.S. pursuant to Regulation S under the Securities Act and to accredited investors in Canada pursuant to applicable private placement exemptions.

The 2016 Fixed Rate Notes issued May 2008 were issued as additional notes under an existing indenture dated as of July 5, 2006, as supplemented, and are part of the same class as NNL’s currently outstanding $450 aggregate principal amount of 10.75% Senior Notes due 2016 that were issued on July 5, 2006 (the “2016 Fixed Rate Notes issued July 2006”) under the same indenture. The 2016 Fixed Rate Notes issued May 2008 and the 2016 Fixed Rate Notes issued July 2006 have the same ranking, guarantee structure, interest rate, maturity date and other terms, and are treated as a single class of securities under the indenture, and holders of the 2016 Fixed Rate Notes issued May 2008 and the 2016 Fixed Rate Notes issued July 2006 vote together as one class. Refer to note 10, “Long-term debt”, to the audited consolidated financial statements accompanying the 2007 Annual Report for additional details regarding terms. The 2016 Fixed Rate Notes issued May 2008 and related guarantees have not been registered under the Securities Act or the securities laws of any other place and may not be offered or sold within the U.S. or to, or for the account or benefit of, a U.S. person except in transactions exempt from, or not subject to, the registration requirements of the Securities Act and applicable securities laws in other jurisdictions. The 2016 Fixed Rate Notes issued May 2008 and related guarantees are currently not fungible for trading purposes with the 2016 Fixed Rate Notes issued July 2006.

The net proceeds received from the sale of the 2016 Fixed Rate Notes issued May 2008 were approximately $655, after deducting the discount on issuance of $7 and commissions and other offering expenses of $13. On June 16, 2008, Nortel used these net proceeds, together with available cash, to redeem, at par, $675 outstanding principal amount of Nortel’s 4.25% convertible senior notes due September 1, 2008 (“4.25% Notes due 2008”) plus accrued and unpaid interest.

 

11. Guarantees

Nortel has entered into agreements containing features that meet the definition of a guarantee under FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Other”. As of September 30, 2008, Nortel accrued nil in respect of its non-contingent obligations associated with these agreements and $10 with respect to its contingent obligations that are considered probable to occur.

 

28


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

The following table provides a summary of Nortel’s guarantees as of September 30, 2008:

 

     Carrying
Amount of
Liability
   Maximum
Potential
Liability(l)

Business sale and business combination agreements

     

Third party claims(a)

   $ 10    $ 14

Sales volume guarantee(b)

     —        —  

Intellectual property indemnification obligations(c)

     —        —  

Lease agreements(d)

     —        38

Receivable securitizations(e)

     —        15

Other indemnification agreements

     

EDC Support Facility(f)

     —        —  

Specified price trade-in rights(g)

     —        1

Global Class Action Settlement (as defined in note 18)(h)

     —        —  

Sale lease-back(i)

     —        4

Real estate indemnification(j)

     —        —  

Bankruptcy(k)

     —        1
             

Total

   $ 10    $ 73
             

 

(a) Includes guarantees in connection with agreements for the sale of all or portions of an investment or a Nortel business, including certain discontinued operations and guarantees related to the escrow of shares in business combinations in prior periods. Nortel has indemnified the purchaser of an investment or a Nortel business in the event that a third party asserts a claim against the purchaser that relates to a liability retained by Nortel relating to business events occurring prior to the sale, such as tax, environmental, litigation and employment matters. In certain agreements, Nortel also indemnifies counterparties for losses incurred from litigation that may be suffered by counterparties arising under guarantees related to the escrow of shares in business combinations. Some of these types of guarantees have indefinite terms while others have specific terms extending to no later than 2012.
(b) In conjunction with the sale of a subsidiary to a third party, Nortel guaranteed to the purchaser that specified annual sales volume levels would be achieved by the business sold over a ten-year period ended December 31, 2007. Nortel’s guarantee to the purchaser was governed by the laws of the purchaser’s jurisdiction. As such, the purchaser has the right to claim such payments under the volume guarantee until January 31, 2018, under the statute of limitations of such jurisdiction.
(c) Nortel has periodically entered into agreements with customers and suppliers that include intellectual property indemnification obligations that are customary in the industry. These agreements generally require Nortel to compensate the other party for certain damages and costs incurred as a result of third party intellectual property claims arising from these transactions. These types of guarantees typically have indefinite terms; however, under some agreements, Nortel has provided specific terms extending to February 2011.
(d) Nortel has entered into agreements with its lessors to guarantee the lease payments of certain assignees of its facilities. Generally, these lease agreements relate to facilities Nortel vacated prior to the end of the term of its lease. These lease agreements require Nortel to make lease payments throughout the lease term if the assignee fails to make scheduled payments. Most of these lease agreements also require Nortel to pay for facility restoration costs at the end of the lease term if the assignee fails to do so. These lease agreements have expiration dates through June 2015.
(e) Nortel has agreed to indemnify certain of its counterparties in certain receivables securitization transactions. Certain receivables securitization transactions include indemnifications requiring the repurchase of the receivables, under certain conditions, if the receivable is not paid by the obligor. The indemnification provisions generally expire upon the earlier of either expiration of the securitization agreements, which extend through 2008, or collection of the receivable amounts by the purchaser.
(f)

On February 14, 2003, NNL entered into an agreement with Export Development Canada (“EDC”) regarding arrangements to provide support for certain performance-related obligations arising out of normal course business (the “EDC Support Facility”). Nortel has also agreed to indemnify EDC under the EDC Support Facility against any legal

 

29


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

 

action brought against EDC that relates to the provision of support under the EDC Support Facility. Effective December 14, 2007, NNL and EDC amended and restated the EDC Support Facility, among other things, to extend the maturity date to December 31, 2011 and to provide for automatic renewal each subsequent year, unless either party provides written notice to the other of its intent to terminate. As of September 30, 2008, there was approximately $193 of outstanding support utilized under the EDC Support Facility, approximately $130 of which was outstanding under the revolving small bond sub-facility, with the remaining balance under the revolving large bond sub-facility.

(g) Nortel has identified specified price trade-in rights in certain customer arrangements that qualify as guarantees. These types of guarantees generally apply over a specified period of time and extend through to June 2010.
(h) On March 17, 2006, in connection with the Global Class Action Settlement (as defined in note 18), Nortel announced that it had reached an agreement with the lead plaintiffs on the related insurance and corporate governance matters, including Nortel’s insurers agreeing to pay $229 in cash towards the settlement and Nortel agreeing with its insurers to certain indemnification obligations. Nortel believes that it is unlikely that these indemnification obligations will materially increase its total cash payment obligations under the Global Class Action Settlement.
(i) On June 27, 2007, NNL entered into a sale lease-back agreement where it agreed to provide an indemnity to the purchaser with respect to union and employee termination matters. The sale agreement requires NNL to compensate the purchaser for any costs in the event that NNL fails to effectively satisfy termination obligations to union employees; if a reinstatement application is brought by the union or non-union employees; or if the purchaser is required to re-hire selected union employees. The indemnification provision expires upon the retirement of the last former employee. The nature of the indemnification prevents Nortel from making a reasonable estimate of the maximum term of the indemnification.
(j) On February 14, 2008, Nortel Networks Inc. (“NNI”) entered into an agreement whereby it indemnified the landlord of a property against certain claims that the sub-tenant may assert against the landlord. The nature of the indemnification prevents Nortel from making a reasonable estimate of the maximum term of the indemnification.
(k) On February 28, 2008, NNL entered into a guarantee agreement in which it agreed to repay to the bankruptcy estate of a certain debtor, any interim dividends paid from the bankruptcy estate that NNL is not entitled to in the event that a creditor steps forward with a claim that requires a re-distribution of funds between the creditors. The nature of the indemnification prevents Nortel from making a reasonable estimate of the maximum term of the indemnification.
(l) The nature of some guarantees and indemnification arrangements generally prevents Nortel from making a reasonable estimate of the maximum potential amount it could be required to pay under such agreements. For this reason, no amount has been included in the disclosure in these circumstances.

Product warranties

The following summarizes the accrual for product warranties that were recorded as part of other accrued liabilities in the condensed consolidated balance sheet as of September 30, 2008:

 

Balance as of December 31, 2007

   $ 214  

Payments

     (138 )

Warranties issued

     164  

Revisions

     (42 )
        

Balance as of September 30, 2008

   $ 198  
        

 

12. Fair Value

Nortel adopted the provisions of SFAS 157 applicable to financial assets and liabilities and to certain non-financial assets and liabilities that are measured at fair value on a recurring basis, effective January 1, 2008. SFAS 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. SFAS 157, among other things, requires Nortel to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

30


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Fair value hierarchy

SFAS 157 provides a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Nortel’s assumptions with respect to how market participants would price an asset or liability. These two inputs used to measure fair value fall into the following three different levels of the fair value hierarchy:

Level 1: Quoted prices for identical instruments in active markets that are observable.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are non-active; inputs other than quoted prices that are observable and derived from or corroborated by observable market data.

Level 3: Valuations derived from valuation techniques in which one or more significant inputs are unobservable.

This hierarchy requires the use of observable market data when available.

Determination of fair value

The following section describes the valuation methodologies used by Nortel to measure different instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is classified. Where applicable, the descriptions include the key inputs and significant assumptions used in the valuation models.

Investments

When available, Nortel uses quoted market prices to determine fair value of certain exchange-traded equity securities; such items are classified in Level 1 of the fair value hierarchy.

Certain investments are valued using the Black-Scholes-Merton option-pricing model. Key inputs include the exchange-traded price of the underlying security, exercise price, shares issuable, risk-free rate, forecasted dividends and volatility. Such items are classified in Level 2 of the fair value hierarchy.

Nortel has an investment in a money market fund, which, prior to the suspension of trading activities of the fund’s shares, was classified as cash and cash equivalents. The fund recently announced that its net asset value had declined to $0.97 per share relative to par of $1.00 per share and that it was temporarily suspending redemption rights as it sought SEC approval of its plan for orderly liquidation of its assets. These investments are currently classified in Level 2 of the fair value hierarchy. See notes 3 and 19 for more information.

As of September 30, 2008, Nortel held $19 in auction rate securities which it classified as an available-for-sale investment. At September 30, 2008, there were no active markets for these auction rate securities or comparable securities due to current market conditions. Therefore, until such a market becomes active, Nortel is determining their fair value based on expected discounted cash flows, incorporating current coupon rates and expected maturity dates. Such items are currently classified in Level 3 of the fair value hierarchy.

Derivatives

The majority of derivatives entered into by Nortel are valued using standard valuation techniques as no quoted market prices exist for the instruments. The valuation technique used and inputs required depend on the type of

 

31


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

derivative. The principal techniques used to value these instruments are through comparing the rates at the time that the derivatives were acquired to the period-end rates quoted in the market. Depending on the type of derivative, the valuation could be calculated through either discounted cash flows or the Black-Scholes-Merton option-pricing model. The key inputs depend upon the type of derivative, and include interest rate yield curves, foreign exchange spot and forward rates, and expected volatility. The item is placed in Level 2 or Level 3 depending on whether the significant inputs are observable or not. Level 2 includes Nortel’s hedging activities. Level 3 includes embedded derivatives related to commercial or purchase contracts.

Long-term debt

Nortel’s publicly traded debt instruments are valued using quoted market prices and are classified as Level 1 in the fair value hierarchy.

Market valuation adjustments

The fair value of derivatives and other financial liabilities includes the effects of Nortel’s and the counterparty’s non-performance risk, including credit risk. Nortel has incorporated its own and its counterparty’s credit risk into the determination of fair value of its derivatives, where applicable. See note 13 for more information.

The following table presents, for each of the fair value hierarchy levels, the assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2008:

 

     Fair Value    Level 1    Level 2    Level 3

Assets

           

Money market fund

   $ 352    $ —      $ 352    $ —  

Employee benefit trust

     83      83      —        —  

Derivatives

     71      —        61      10

Auction rate securities

     19      —        —        19
                           

Total assets

   $ 525    $ 83    $ 413    $ 29
                           

Liabilities

           

Long-term debt

     2,460      2,460      —        —  

Derivatives

     36      —        36      —  
                           

Total liabilities

   $ 2,496    $ 2,460    $ 36    $ —  
                           

The following table presents the changes in the Level 3 fair value category for the nine months ended September 30, 2008:

 

     January 1,
2008
   Net Realized/Unrealized Gains
(Losses) included in
   Purchases,
Sales, Issuances
and

(Settlements)—net
   Transfers in
and/or (out)
of

Level 3
   September 30,
2008
              Earnings                 Other               

Assets

                

Derivatives

   $ 1    9     —      —      —      $ 10

Auction rate securities

     —      —       —      19    —      $ 19

Liabilities

                

Derivatives

   $ 5    (5 )   —      —      —      $ —  

 

32


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

13. Commitments

Bid, performance-related and other bonds

Nortel has entered into bid, performance-related and other bonds associated with various contracts. Bid bonds generally have a term of less than twelve months, depending on the length of the bid period for the applicable contract. Other bonds primarily relate to warranty, rental, real estate and customs contracts. Performance-related and other bonds generally have a term consistent with the term of the underlying contract. The various contracts to which these bonds apply generally have terms ranging from one to five years. Any potential payments which might become due under these bonds would be related to Nortel’s non-performance under the applicable contract. Historically, Nortel has not had to make material payments under these types of bonds and does not anticipate that any material payments will be required in the future.

The following table sets forth the maximum potential amount of future payments under bid, performance-related and other bonds, net of the corresponding restricted cash and cash equivalents, as of:

 

     September 30,
2008
   December 31,
2007

Bid and performance-related bonds(a)

   $ 175    $ 155

Other bonds(b)

     59      54
             

Total bid, performance related and other bonds

   $ 234    $ 209
             

 

(a) Net of restricted cash and cash equivalent amounts of $4 and $5 as of September 30, 2008 and December 31, 2007, respectively.
(b) Net of restricted cash and cash equivalent amounts of $7 and $27 as of September 30, 2008 and December 31, 2007, respectively.

Venture capital financing

Nortel has entered into agreements with selected venture capital firms where the venture capital firms make and manage investments in start-up businesses and emerging enterprises. The agreements require Nortel to fund requests for additional capital up to its commitments when and if requests for additional capital are solicited by any of the venture capital firms. Nortel had remaining commitments, if requested, of $19 as of September 30, 2008. These commitments expire at various dates through to 2017.

Concentrations of risk

Nortel from time to time uses derivatives to limit exposures related to foreign currency, interest rate and equity price risk. Credit risk on these financial instruments arises from the potential for counterparties to default on their contractual obligations to Nortel. Nortel is exposed to credit risk in the event of non-performance, but does not anticipate non-performance by any of the counterparties to its financial instruments. Nortel limits its credit risk by dealing with counterparties that are considered to be of reputable credit quality.

Nortel’s cash and cash equivalents are maintained with several financial institutions in the form of demand and term bank deposits and government and institutional short-term money market instruments. Generally, these funds may be redeemed upon demand and are maintained with financial institutions with reputable credit and therefore are expected to bear minimal credit risk. Nortel seeks to mitigate such risks by spreading its risk across multiple counterparties and monitoring the risk profiles of these counterparties.

Nortel performs ongoing credit evaluations of its customers and, with the exception of certain financing transactions, does not normally require collateral from its customers. Nortel’s customers are primarily in the

 

33


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

enterprise and telecommunication service provider markets. Nortel’s global market presence has resulted in a large number of diverse customers which reduces concentrations of credit risk.

Nortel receives certain of its components from sole suppliers. Additionally, Nortel relies on a limited number of contract manufacturers and suppliers to provide manufacturing services for its products. The inability of a contract manufacturer or supplier to fulfill supply requirements of Nortel could materially impact future operating results.

WiMAX Strategic Agreement with Alvarion Ltd.

On June 11, 2008, Nortel entered into an agreement with Alvarion Ltd. (“Alvarion”), to jointly develop a WiMAX product solution. For the duration of the agreement, Nortel has agreed to terminate its current IEEE 802.16e macro WiMAX BTS commercial product development and instead work with Alvarion to continue the development of a world leading mobile WiMAX (802.16e) portfolio of access products. Nortel is not committed to any purchase commitments under the agreement. Alvarion will provide the R&D work for the joint WiMAX BTS product solution, with the funding assistance, development and engineering expertise provided by Nortel. Nortel will pay Alvarion an agreed amount of R&D funding over the four year term of the agreement.

 

14. Loss per common share

The following table details the weighted-average number of NNC common shares outstanding for the purposes of computing basic and diluted earnings (loss) per common share for the following periods:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
       2008(a)(b)         2007(a)        2008(a)(b)         2007(a)(b)    
(Number of common shares in millions)                        

Net loss

   $ (3,413 )   $ 27    $ (3,664 )   $ (113 )
                               

Basic weighted-average shares outstanding:

         

Issued and outstanding

     498       497      498       479  
                               

Basic weighted-average shares outstanding

     498       497      498       479  
                               

Weighted-average shares dilution adjustments:

         

Dilutive stock options and share-based awards

     —         3      —         —    
                               

Diluted weighted-average shares outstanding

     498       500      498       479  
                               

Weighted-average shares dilution adjustments—exclusions:

         

Stock options and other share-based awards

     39       28      39       31  

4.25% Notes due 2008 as defined in noted 20(b)

     —         7      —         7  

2012 Notes as defined in note 20(b)

     18       18      18       18  

2014 Notes as defined in note 20(b)

     18       18      18       18  
                               

Basic and diluted earnings (loss) per common share

   $ (6.85 )   $ 0.05    $ (7.36 )   $ (0.24 )
                               

 

(a) Shares issued or issuable as a result of the Global Class Action Settlement (as defined in note 18) of 62,866,775 for the three and nine months ended September 30, 2008, as well as 62,866,775 and 44,904,839 for the three and nine months ended September 30, 2007, respectively, have been included in the calculation of basic and diluted weighted-average number of NNC common shares outstanding with effect from March 20, 2007. For additional information, see note 18.
(b) As a result of net loss for the nine months ended September 30, 2008 and 2007 and the three months ended September 30, 2008, all potential dilutive securities in these periods were considered anti-dilutive.

 

34


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

15. Shareholders’ equity (deficit)

The following are the changes in shareholders’ equity (deficit) during the nine months ended September 30, 2008 (numbers of common shares in thousands):

 

            Additional
paid-in
capital
    Accumulated
deficit
    Accumulated
other
comprehensive
income (loss)
    Total  
  Common shares        

Balance as of December 31, 2007

  437,423   $ 34,028   $ 5,025     $ (36,532 )   $ 237     $ 2,758  

Adoption of SFAS 158 (notes 2 and 8)

  —       —       —         (33 )     5       (28 )

Net loss

  —       —       —         (3,664 )     —         (3,664 )

Foreign currency translation adjustment

  —       —       —         —         (189 )     (189 )

Unrealized loss on investments—net

  —       —       —         —         (12 )     (12 )

Unamortized pension and post-retirement actuarial losses and prior service cost—net

  —       —       —         —         2       2  

Issuance of NNC common shares related to settlement

  59,096     1,530     (1,530 )     —         —         —    

Share-based compensation

  892     22     44       —         —         66  

Other

  46     1     (1 )     —         —         —    
                                         

Balance as of September 30, 2008

  497,457   $ 35,581   $ 3,538     $ (40,229 )   $ 43     $ (1,067 )
                                         

Nortel is authorized to issue an unlimited number of NNC common shares without nominal or par value.

The following are the components of comprehensive income (loss), net of tax, for the following periods:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2008             2007             2008             2007      

Net earnings (loss)

   $ (3,413 )   $ 27     $ (3,664 )   $ (113 )

Other comprehensive income (loss) adjustments:

        

Change in foreign currency translation adjustment

     (169 )     36       (189 )     120  

Unrealized loss on investments—net(a)

     (4 )     (6 )     (12 )     (9 )

Unamortized pension and post-retirement acturial losses and prior service cost—net

     5       13       2       42  

Unrealized derivative gain (loss) on cash flow hedges—net(b)

     —         (1 )     —         28  

Other

     (2 )     —         —         —    
                                

Comprehensive income (loss)

   $ (3,583 )   $ 69     $ (3,863 )   $ 68  
                                

 

(a) Certain securities deemed available-for-sale by Nortel are measured at fair value. Unrealized holding losses related to these securities are excluded from net loss and are included in accumulated other comprehensive income until realized. Unrealized loss on investments was net of tax of nil for the three and nine months ended September 30, 2008 and 2007.
(b) During the three and nine months ended September 30, 2008 and 2007, nil and nil and $9 and $4, respectively, of net derivative gains were reclassified to other income (expense)—net. Nortel has no net remaining derivative gain (loss) on cash flow hedges included in accumulated other comprehensive income.

 

16. Share-based compensation plans

At the annual meeting of Nortel’s shareholders held on May 7, 2008, the following amendments to the Nortel Networks Corporation 2005 Stock Incentive Plan, As Amended and Restated (the “SIP”) were approved by

 

35


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Nortel’s shareholders in accordance with the rules of the Toronto Stock Exchange (“TSX”) and NYSE and the terms of the SIP: (i) an increase in the number of NNC common shares issuable under the SIP by 14 million from 12.2 million to 26.2 million; (ii) the addition of certain additional types of amendments to the SIP or awards under it requiring shareholder approval; and (iii) amendments to reflect current market practices with respect to blackout periods.

Options

Prior to 2006, Nortel granted options to employees to purchase NNC common shares under two existing option plans, the Nortel Networks Corporation 2000 Stock Option Plan (the “2000 Plan”) and the Nortel Networks Corporation 1986 Stock Option Plan, As Amended and Restated (the “1986 Plan”). Under these two plans, options to purchase NNC common shares could be granted to employees and, under the 2000 Plan, options could also be granted to directors of Nortel. NNC common shares remaining available for grant after December 31, 2005 under the 2000 Plan and the 1986 Plan (and including NNC common shares that become available upon expiration or termination of options granted under such plans) were transferred to and were available for grant under the SIP, effective January 1, 2006.

During the nine months ended September 30, 2008, there were not a significant number of NNC common shares issued pursuant to the exercise of options granted under the 1986 Plan or the 2000 Plan. During the nine months ended September 30, 2008, 4,468,842 options were granted under the SIP. During the nine months ended September 30, 2008, the number of options exercised under the SIP was nil.

The following is a summary of the total number of outstanding options under the SIP, the 2000 Plan and the 1986 Plan, and the maximum number of options available for grant under the SIP:

 

     Outstanding
Options
(Thousands)
    Weighted-
Average
Exercise
Price
   Weighted-
Average
Life
(In Years)
   Aggregate
Intrinsic
Value
(Thousands)
   Available
for Grant
(Thousands)
 

Balance at December 31, 2007

   29,210     $ 75.30    5.6    $ 69    13,514  

New available common shares

              14,000 (b)

Options granted

   4,469     $ 8.18       $ —      (10,143 )(a)

Options exercised

   —       $ —         $ —      —   (a)

Options forfeited

   (627 )   $ 24.08          938 (a)

Options expired

   (2,467 )   $ 151.76          2,445 (a)

Options cancelled

   (7 )   $ 8.29          41 (a)
                               

Balance at September 30, 2008

   30,578     $ 59.09    6.0    $ 7    20,795 (c)
                               

 

(a) Amount is inclusive of Restricted Stock Units (“RSUs”) and Performance Stock Units (“PSUs”) granted, cancelled, forfeited or expired, as applicable. RSUs and PSUs reduce the number of NNC common shares available for grant under the SIP.
(b) Represents the additional 14,000 NNC common shares that were approved for issuance under the SIP by shareholders on May 7, 2008.
(c) Includes 14,042 NNC common shares available for issuance under the SIP in connection with awards of RSUs and/or PSUs.

Stock Appreciation Rights (“SARs”)

During the nine months ended September 30, 2008, Nortel granted 31,199 stand-alone SARs under the SIP. As of September 30, 2008, 105,358 stand-alone SARs are outstanding under the SIP. The SARs awarded under the SIP

 

36


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

program will be settled in cash at the time of exercise. All SARs granted have been classified as liability awards based on their cash settlement provisions. As of September 30, 2008, no tandem SARs have been granted under the SIP.

RSUs

During the nine months ended September 30, 2008, 3,745,439 RSUs were granted under the SIP, of which 109,157 are to be settled in cash due to certain country-specific rules and regulations. Nortel accounts for these cash settled grants as liability awards. All other granted RSUs are settled in shares based on the terms and conditions of the respective grants and as such have been classified as equity instruments based on the settlement provisions of the SIP. During the nine months ended September 30, 2008, there were approximately 892,000 NNC common shares issued pursuant to the vesting of RSUs granted under the SIP.

The following is a summary of the total number of outstanding share-based RSU awards under the SIP as of the following dates:

 

     RSU
     RSU
Awards
Granted
(Thousands)(a)
    Weighted-
Average
Grant Date
Fair Value
   Weighted-
Average
Contractual
Life
(In Years)

Balance as of December 31, 2007

   2,706     $ 24.86    2.2

Awards granted

   3,636       7.98   

Awards settled

   (897 )(b)     24.89   

Awards forfeited

   (249 )     17.99   

Awards cancelled

   (34 )     8.04   
                 

Balance as of September 30, 2008

   5,162     $ 13.41    2.3
                 

 

(a) Does not include cash-settled RSU awards granted by Nortel.
(b) Includes 5 RSUs not settled with NNC common shares that were withheld due to certain withholding tax obligations.

PSUs

Relative Total Shareholder Return Metric Awards (“PSU-rTSRs”)

Prior to January 1, 2008 all awards of PSU-rTSRs (previously defined as “PSUs” in the 2007 Annual Report) under the SIP had vesting conditions based on the relative total shareholder return metric and had a 36-month performance period. In March 2008, Nortel determined that awards of PSU-rTSRs granted after January 1, 2008 would have a 36-month performance period and an additional 30-day employment service period. All other vesting conditions with respect to PSU-rTSRs as of September 30, 2008 remain consistent with the conditions as reported in the 2007 Annual Report. The number of NNC common shares issued for vested PSU-rTSRs can range from 0% to 200% of the number of PSU-rTSR awards granted.

During the nine months ended September 30, 2008, 785,475 PSU-rTSRs were granted under the SIP, of which 6,175 are to be settled in cash due to certain country-specific rules and regulations. Nortel accounts for these cash settled grants as liability awards. All other such granted PSU-rTSRs are settled in shares based on the terms and conditions of the respective grants and as such have been classified as equity instruments based on the settlement provisions of the SIP. During the nine months ended September 30, 2008, there were no PSU-rTSRs that vested under the SIP.

 

37


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

The following is a summary of the total number of outstanding share-based PSU-rTSRs under the SIP as of the following dates:

 

     PSU-rTSR
     PSU-rTSR
Awards
Granted
(Thousands)(a)
    Weighted-
Average
Grant Date
Fair Value
   Weighted-
Average
Contractual
Life
(In Years)

Balance as of December 31, 2007

   820     $ 21.96    1.5

Awards granted

   779       6.84   

Awards settled

   —         —     

Awards forfeited

   (38 )     19.90   

Awards expired

   —         —     
                 

Balance as of September 30, 2008

   1,561     $ 14.46    1.3
                 

 

(a) Does not include cash-settled PSU-rTSR awards granted by Nortel.

Management Operating Margin Metric Awards (“PSU-Management OMs”)

In March 2008, Nortel awarded PSU-Management OMs (previously defined as “PSU-OMs” in its Quarterly Report on Form 10-Q for the quarter ended March 31, 2008) with the following two vesting conditions: (i) the participant must satisfy a one-year performance period and an additional 24-month vesting period in which continuous employment is required; and (ii) Nortel’s Management OM must exceed the minimum threshold level of 4.80% or $550 in accordance with Nortel’s payout curve for a one year performance period. The number of NNC common shares to be issued for vested PSU-Management OMs is determined based on Nortel’s Management OM and can range from 0% to 200% of the number of PSU-Management OM awards granted. The awards vest in full at the end of the 36-month employment period, subject to the satisfaction of the two vesting conditions. Generally, the PSU-Management OMs granted under the SIP will be settled in shares at the time of vesting.

During the nine months ended September 30, 2008, 1,274,885 PSU-Management OMs were granted under the SIP, of which 15,325 are to be settled in cash due to certain country-specific rules and regulations. Nortel accounts for these cash settled grants as liability awards. All other PSU-Management OMs granted are settled in shares based on the terms and conditions of the respective grants and as such have been classified as equity instruments based on the settlement provisions of the SIP. During the nine months ended September 30, 2008, there were no PSU-Management OMs that vested under the SIP.

 

38


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

The following is a summary of the total number of outstanding share-based PSU-Management OMs under the SIP as of the following dates:

 

     PSU-Management OM
     PSU-Management
OM

Awards
Granted
(Thousands)(a)
    Weighted-
Average
Grant Date
Fair Value
   Weighted-
Average
Contractual
Life
(In Years)

Balance as of December 31, 2007

   —       $ —     

Awards granted

   1,259       7.92   

Awards settled

   —         —     

Awards forfeited

   (24 )     8.05   

Awards expired

   —         —     

Adjustment(b)

   —         —     
                 

Balance as of September 30, 2008

   1,235     $ 7.92    2.3
                 

 

(a) Does not include cash-settled PSU-Management OMs granted by Nortel.
(b) Estimated number of NNC common shares to be issued based on PSU-Management OM awards expected to vest based on the full-year Management OM forecast as of September 30, 2008 and Nortel’s payout curve in accordance with the terms and conditions of the grant is 482.

Share-based compensation

The following table provides the share-based compensation expense recorded for the following periods:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
         2008             2007            2008            2007    

Share-based compensation:

          

DSU expense

   $ 1     $ —      $ 2    $ —  

Option expense

     14       23      35      64

RSU expense

     7       7      22      17

PSU expense—rTSR

     1       1      5      5

PSU expense—Management OM

     (1 )     —        —        —  
                            

Total share-based compensation reported

   $ 22     $ 31    $ 64    $ 86
                            

Nortel estimates the fair value of options and SARs using the Black-Scholes-Merton option-pricing model, consistent with the provisions of SFAS 123R, “Share-based payments” (“SFAS 123R”) and Staff Accounting Bulletin 107, “Disclosures about Fair Value of Financial Instruments” (“SAB 107”). The key input assumptions used to estimate the fair value of awards include the grant price of the award, the expected term of the award, the volatility of NNC common shares, the risk-free rate, and Nortel’s dividend yield. Nortel believes that the Black-Scholes-Merton option-pricing model adequately captures the substantive features of option awards and is appropriate in calculating the fair values of Nortel’s options and SARs.

 

39


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

The following ranges of assumptions were used in computing the fair value of options and SARs for purposes of expense recognition, for the following periods:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2008     2007     2008     2007  

Black-Scholes-Merton assumptions

       

Expected dividend yield

  0.00 %   0.00 %   0.00 %   0.00 %

Expected volatility(a)

  51.76% – 61.51 %   51.07% – 52.33 %   44.21% – 61.51 %   51.07% – 53.56 %

Risk-free interest rate(b)

  1.96% – 3.20 %   4.25% –4.72 %   1.96% –3.33 %   4.25% –4.92 %

Expected life in years(c)

  2.64 – 4.50     3.65 – 4.00     2.64 – 4.50     3.65 – 4.00  

Range of fair value per option granted

  $2.72 – $2.73     $7.90 – $8.74     $2.72 – $3.78     $7.90 – $11.86  

Range of fair value per SAR granted

  $0.02 – $0.30     $4.94     $0.02 – $3.13     $4.94 – $10.92  

 

(a) The expected volatility of NNC common shares is estimated using the daily historical share prices over a period equal to the expected term.
(b) Nortel used the five year U.S. government Treasury Note rate to approximate the risk-free rate.
(c) The expected term of the options of four and a half years for 2008 grants is estimated based on historical grants with similar vesting periods.

The fair value of all RSUs and PSU-Management OMs granted after January 1, 2008 is calculated using the closing share price from NYSE on the date of the grant. For RSU awards granted before January 1, 2008, the fair value is calculated using an average of the high and low share prices from the highest trading value of either the NYSE or TSX on the date of the grant. There were no PSU- Management OMs granted before January 1, 2008. Nortel estimates the fair value of PSU-rTSRs awards using a Monte Carlo simulation model. Certain assumptions used in the model include (but are not limited to) the following:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2008     2007     2008     2007  

Monte Carlo assumptions

        

Beta(a)

   —       1.53 – 1.58     —       1.53 – 1.88  

Historical volatility(a)

   2.30% – 2.50 %   4.15% – 4.66 %   1.64% – 2.50 %   4.15% – 4.66 %

Risk-free interest rate(b)

   46.82% – 46.88 %   —       43.96% – 46.88 %   —    

 

(a) Commencing in the first quarter of 2008, Nortel employed a three-year historical volatility as an input in to the Monte Carlo simulation model to match the life expectancy of PSU-rTSRs. Previously, Nortel had used Beta as an input into the model.
(b) The risk-free rate used was based on the yield of the two year U.S. government Treasury Note rate.

Cash received from exercises under all share-based compensation arrangements was nil and $10 for the nine months ended September 30, 2008 and 2007, respectively. Tax benefits realized by Nortel related to these exercises were nil for the nine months ended September 30, 2008 and 2007.

 

17. Related party transactions

In the ordinary course of business, Nortel engages in transactions with certain of its equity-owned investees and certain other business partners. These transactions are sales and purchases of goods and services under usual trade terms and are measured at their exchange amounts.

 

40


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Transactions with related parties are summarized for the following periods:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
         2008            2007            2008            2007    

Revenues:

           

LG Electronics Inc.(a)

   $ 4    $ 5    $ 20    $ 17

Vertical Communications Systems Inc. (“Vertical”)(b)

     3      4      9      10

Other

     3      1      8      6
                           

Total

   $ 10    $ 10    $ 37    $ 33
                           

Purchases:

           

LG Electronics Inc.(a)

     36      63      133      245

Sasken Communications Technology Ltd. (“Sasken”)(c)

     —        7      11      20

GN TEL Co., Ltd. (“GN TEL”)(d)

     18      29      61      69

Other

     4      5      15      12
                           

Total

   $ 58    $ 104    $ 220    $ 346
                           

 

(a) LGE holds a minority interest in LG-Nortel. Nortel’s sales and purchases relate primarily to certain inventory-related items. As of September 30, 2008, accounts payable to LGE was net $26, compared to net $31 as of December 31, 2007.
(b) LG-Nortel currently owns a minority interest in Vertical. Vertical supports LG-Nortel’s efforts to distribute Nortel’s products to the North American market.
(c) Nortel currently owns a minority interest in Sasken. Nortel’s purchases from Sasken relate primarily to software and software development-related purchases.
(d) Nortel holds a minority interest in GN TEL through its joint venture LG-Nortel. Nortel’s purchases from GN TEL relate primarily to installation and warranty services. As of September 30, 2008, accounts payable to GN TEL was net $13, compared to net $31 as of December 31, 2007.

As of September 30, 2008 and December 31, 2007, accounts receivable from related parties were $4 and $6, respectively. As of September 30, 2008 and December 31, 2007, accounts payable to related parties were $40 and $67, respectively.

 

18. Contingencies

Subsequent to Nortel’s announcement on February 15, 2001, in which it provided revised guidance for its financial performance for the 2001 fiscal year and the first quarter of 2001, Nortel and certain of its then-current officers and directors were named as defendants in several purported class action lawsuits in the U.S. and Canada (collectively, the “Nortel I Class Actions”). These lawsuits in the U.S. District Court for the Southern District of New York, where all the U.S. lawsuits were consolidated, the Ontario Superior Court of Justice, the Supreme Court of British Columbia and the Quebec Superior Court were filed on behalf of shareholders who acquired securities of Nortel during certain periods between October 24, 2000 and February 15, 2001. The lawsuits alleged, among other things, violations of U.S. federal and Canadian provincial securities laws. These matters also had been the subject of review by Canadian and U.S. securities regulatory authorities.

Subsequent to Nortel’s announcement on March 10, 2004, in which it indicated it was likely that Nortel would need to revise its previously announced unaudited results for the year ended December 31, 2003 and the results reported in certain of its quarterly reports in 2003, and to restate its previously filed financial results for one or more earlier periods, Nortel and certain of its then-current and former officers and directors were named as defendants in several purported class action lawsuits in the U.S. and Canada (collectively, the “Nortel II

 

41


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Class Actions”). These lawsuits in the U.S. District Court for the Southern District of New York, the Ontario Superior Court of Justice and the Quebec Superior Court were filed on behalf of shareholders who acquired securities of Nortel during certain periods between February 16, 2001 and July 28, 2004. The lawsuits alleged, among other things, violations of U.S. federal and Canadian provincial securities laws, negligence, misrepresentations, oppressive conduct, insider trading and violations of Canadian corporation and competition laws in connection with certain of Nortel’s financial results. These matters had been the subject of review by Canadian and U.S. securities regulatory authorities and are the subject of investigations by Canadian and U.S. criminal investigative authorities.

During 2006, Nortel entered into agreements to settle all of the Nortel I Class Actions and Nortel II Class Actions (the “Global Class Action Settlement”) concurrently, except for an action in the Ontario Superior Court of Justice that was settled (the “Ontario Settlement”) by the parties and approved by the court in February 2007. In December 2006 and January 2007, the Global Class Action Settlement was approved by the courts in New York, Ontario, British Columbia and Quebec, and became effective on March 20, 2007.

Under the terms of the Global Class Action Settlement, Nortel agreed to pay $575 in cash plus accrued interest and issue 62,866,775 NNC common shares (representing approximately 14.5% of NNC common shares outstanding as of February 7, 2006, the date an agreement in principle was reached with the plaintiffs in the U.S. class action lawsuits). Nortel will also contribute to the plaintiffs one-half of any recovery from its ongoing litigation against certain of its former senior officers who were terminated for cause in 2004, which seeks the return of payments made to them in 2003 under Nortel’s bonus plan. The total settlement amount includes all plaintiffs’ court-approved attorneys’ fees. On June 1, 2006, Nortel placed $575 plus accrued interest of $5 into escrow and classified this amount as restricted cash. As a result of the Global Class Action Settlement, Nortel established a litigation reserve and recorded a charge in the amount of $2,474 to its full-year 2005 financial results, $575 of which related to the cash portion of the Global Class Action Settlement, while $1,899 related to the equity component. The equity component of the litigation reserve was adjusted each quarter from February 2006 through March 20, 2007 to reflect the fair value of the NNC common shares issuable.

The effective date of the Global Class Action Settlement was March 20, 2007, on which date the number of NNC common shares issuable in connection with the equity component was fixed. As such, a final measurement date occurred for the equity component of the settlement and the value of the shares issuable was fixed at their fair value of $1,626 on the effective date.

Nortel recorded a shareholder litigation settlement recovery of $54 during the first quarter of 2007 as a result of the final fair value adjustment for the equity component of the Global Class Action Settlement made on March 20, 2007. In addition, the litigation reserve related to the equity component was reclassified to additional paid-in capital within shareholders’ equity on March 20, 2007 as the number of issuable NNC common shares was fixed on that date. The reclassified amount will be further reclassified to NNC common shares as the shares are issued. On the effective date of March 20, 2007, Nortel also removed the restricted cash and corresponding litigation reserve related to the cash portion of the settlement, as the funds became controlled by the escrow agents and Nortel’s obligation has been extinguished.

Administration of the settlement claims is now substantially complete. Approximately 4% of the settlement shares were issued to certain plaintiffs’ counsel in the first quarter of 2007. Almost all of the remaining settlement shares were distributed in the second quarter of 2008 to claimants and plaintiffs’ counsel, as approved by the courts. The cash portion of the settlement that was placed in escrow in 2006 has now been distributed by the claims administrator to all of the approved claimants, net of an amount held in reserve by the claims administrator to cover contingencies and certain settlement costs.

 

42


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

Nortel’s insurers paid $229 in cash toward the settlement and Nortel agreed to certain indemnification obligations with them. Nortel believes that it is unlikely that these indemnification obligations will materially increase its total cash payment obligations under the Global Class Action Settlement. See note 11 for additional information.

Under the terms of the Global Class Action Settlement, Nortel also agreed to certain corporate governance enhancements. These enhancements included the codification of certain of Nortel’s current governance practices in the written mandate for its Board of Directors and the inclusion in its Statement of Corporate Governance Practices contained in Nortel’s annual proxy circular and proxy statement of disclosure regarding certain other governance practices.

In May 2004, Nortel received a federal grand jury subpoena for the production of certain documents, including financial statements and corporate, personnel and accounting records, in connection with an ongoing criminal investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. In August 2005, Nortel received an additional federal grand jury subpoena seeking additional documents, including documents relating to the Nortel Retirement Income Plan and the Nortel Long-Term Investment Plan. This investigation is ongoing.

Beginning in December 2001, Nortel, together with certain of its then-current and former directors, officers and employees, was named as a defendant in several purported class action lawsuits pursuant to the United States Employee Retirement Income Security Act. These lawsuits have been consolidated into a single proceeding in the U.S. District Court for the Middle District of Tennessee. This lawsuit is on behalf of participants and beneficiaries of the Nortel Long-Term Investment Plan, who held shares of the Nortel Networks Stock Fund during the class period, which has yet to be determined by the court. The lawsuit alleges, among other things, material misrepresentations and omissions to induce participants and beneficiaries to continue to invest in and maintain investments in NNC common shares through the investment plan. The court has not yet ruled as to whether the plaintiff’s proposed class action should be certified.

In January 2005, Nortel and NNL filed a Statement of Claim in the Ontario Superior Court of Justice against Messrs. Frank Dunn, Douglas Beatty and Michael Gollogly, their former senior officers who were terminated for cause in April 2004, seeking the return of payments made to them under Nortel’s bonus plan in 2003.

In April 2006, Mr. Dunn filed a Notice of Action and Statement of Claim in the Ontario Superior Court of Justice against Nortel and NNL asserting claims for wrongful dismissal, defamation and mental distress, and seeking punitive, exemplary and aggravated damages, out-of-pocket expenses and special damages, indemnity for legal expenses incurred as a result of civil and administrative proceedings brought against him by reason of his having been an officer or director of the defendants, pre-judgment interest and costs.

In May and October 2006, respectively, Messrs. Gollogly and Beatty filed Statements of Claim in the Ontario Superior Court of Justice against Nortel and NNL asserting claims for, among other things, wrongful dismissal and seeking compensatory, aggravated and punitive damages, and pre and post-judgment interest and costs.

In March 2008, Nortel entered into an agreement to settle all of the claims raised by Ipernica Limited (formerly known as QPSX Development 5 Pty Ltd) (“Ipernica”), an Australian patent holding firm, in a lawsuit against Nortel filed in the U.S. District Court for the Eastern District of Texas, alleging patent infringement. The settlement agreement between the parties grants to Nortel a perpetual, world-wide license to various Ipernica patents, and includes a covenant not to sue as well as mutual releases, and a payment of $12 was made by NNI to Ipernica in the first quarter of 2008.

 

43


Table of Contents

NORTEL NETWORKS CORPORATION

Notes to Condensed Consolidated Financial Statements (unaudited)—(Continued)

 

On June 19, 2008, the Royal Canadian Mounted Police (the “RCMP”) announced that it had filed criminal charges against three former Nortel executives: Frank Dunn, Douglas Beatty and Michael Gollogly. The fraud-related charges include: fraud affecting the public market, falsification of books and documents, and false prospectus. These charges pertain to allegations of criminal activity within Nortel by these three former executives during 2002 and 2003. No criminal charges were filed against Nortel and Nortel was not the target of this RCMP investigation. Nortel will continue to cooperate with the RCMP during the course of these criminal proceedings.

On June 24, 2008, a purported class action lawsuit was filed in the Ontario Superior Court of Justice in Ottawa, Canada alleging, among other things, that certain recent changes related to Nortel’s pension plan did not comply with the Pension Benefits Act (Ontario) and common law notification requirements. The plaintiffs seek declaratory and equitable relief and unspecified monetary damages. Nortel intends to vigorously defend against these allegations.

Except as otherwise described herein, in each of the matters described above, the plaintiffs are seeking an unspecified amount of monetary damages. Nortel is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Nortel of the above matters, which, unless otherwise specified, seek damages from the defendants of material or indeterminate amounts or could result in fines and penalties. With the exception of $2,474 and the related fair value adjustments which Nortel recorded in 2006 and first quarter of 2007 financial results as a result of the Global Class Action Settlement and the accrued liability for the Ontario Settlement, Nortel has not made any provisions for any potential judgments, fines, penalties or settlements that may result from these actions, suits, claims and investigations. Except for the Global Class Action Settlement, Nortel cannot determine whether these actions, suits, claims and proceedings will, individually or collectively, have a material adverse effect on its business, results of operations, financial condition or liquidity. Except for matters encompassed by the Global Class Action Settlement and the Ontario Settlement, Nortel intends to defend these actions, suits, claims and proceedings, litigating or settling cases where in management’s judgment it would be in the best interest of shareholders to do so. Nortel will continue to cooperate fully with all authorities in connection with the criminal investigations and regulatory and criminal proceedings against former Nortel executives.