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Nortel Networks 10-Q 2009
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended March 31, 2009

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    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  x   Accelerated filer  ¨   Non-accelerated filer  ¨   Smaller reporting company  ¨
   

(Do not check if a 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  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of May 1, 2009.

497,931,093 shares of common stock without nominal or par value

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         PAGE

PART I

FINANCIAL INFORMATION

 

ITEM 1.

   Condensed Combined and Consolidated Financial Statements (unaudited)   1

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations   57

ITEM 3.

   Quantitative and Qualitative Disclosures About Market Risk   107

ITEM 4.

   Controls and Procedures   108

PART II

OTHER INFORMATION

 

ITEM 1.

   Legal Proceedings   110

ITEM 1A.

   Risk Factors   110

ITEM 2.

   Unregistered Sales of Equity Securities and Use of Proceeds   110

ITEM 3.

   Defaults Upon Senior Securities   112

ITEM 5(a).

   Other Information   112

ITEM 6.

   Exhibits   112

SIGNATURES

  114

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

NORTEL, NORTEL (Logo), NORTEL NETWORKS, the Globemark, NT and NORTEL GOVERNMENT SOLUTIONS 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 their respective owners.

 

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PART I

FINANCIAL INFORMATION

 

ITEM 1. Condensed Combined and Consolidated Financial Statements (unaudited)

NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009—note 2)

Condensed Combined and Consolidated Statements of Operations (unaudited)

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

 

     Three months ended March 31,  
         2009             2008      

Revenues:

    

Products

   $ 1,470     $ 2,471  

Services

     263       287  
                

Total revenues

     1,733       2,758  
                

Cost of revenues:

    

Products

     966       1,459  

Services

     142       153  
                

Total cost of revenues

     1,108       1,612  
                

Gross profit

     625       1,146  

Selling, general and administrative expense

     528       597  

Research and development expense

     341       420  

Amortization of intangible assets

     10       12  

Special charges

     —         88  

Gain on sales of businesses and assets

     (15 )     (2 )

Goodwill impairment

     48       —    

Other operating expense (income)—net (note 5)

     (12 )     13  
                

Operating earnings (loss)

     (275 )     18  

Other expense—net (note 5)

     (70 )     (1 )

Interest and dividend income

     —         38  

Interest expense (contractual interest expense for first quarter of 2009 was $80)

    

Long-term debt

     (76 )     (74 )

Other

     (1 )     (6 )
                

Loss from operations before reorganization items, income taxes and equity in net earnings (loss) of associated companies

     (422 )     (25 )

Reorganization items—net (note 4)

     (52 )     —    
                

Loss from operations before income taxes and equity in net earnings of associated companies

     (474 )     (25 )

Income tax expense

     (7 )     (36 )
                

Loss from operations before equity in net earnings of associated companies

     (481 )     (61 )

Equity in net earnings of associated companies—net of tax

     —         1  
                

Net loss

     (481 )     (60 )

Income attributable to noncontrolling interests

     (26 )     (78 )
                

Net loss attributable to Nortel Networks Corporation

   $ (507 )   $ (138 )
                

Basic and diluted loss per common share

   $ (1.02 )   $ (0.28 )
                

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

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009—note 2)

Condensed Combined and Consolidated Balance Sheets (unaudited)

(Millions of U.S. Dollars, except for share amounts)

 

     March 31,
2009
    December 31,
2008
 
ASSETS  

Current assets

    

Cash and cash equivalents

   $ 2,479     $ 2,397  

Short-term investments

     23       65  

Restricted cash and cash equivalents

     92       36  

Accounts receivable—net

     1,692       2,154  

Inventories—net

     1,419       1,477  

Deferred income taxes—net

     27       44  

Other current assets

     489       455  
                

Total current assets

     6,221       6,628  

Investments

     133       127  

Plant and equipment—net

     1,172       1,272  

Goodwill

     131       180  

Intangible assets—net

     129       143  

Deferred income taxes—net

     14       12  

Other assets

     303       475  
                

Total assets

   $ 8,103     $ 8,837  
                
LIABILITIES AND SHAREHOLDERS’ DEFICIT     

Current liabilities

    

Trade and other accounts payable

   $ 420     $ 1,001  

Payroll and benefit-related liabilities

     401       453  

Contractual liabilities

     177       213  

Restructuring liabilities

     22       146  

Other accrued liabilities (note 5)

     2,190       2,674  

Long-term debt due within one year

     3       19  
                

Total current liabilities

     3,213       4,506  

Long-term liabilities

    

Long-term debt

     91       4,501  

Deferred income taxes—net

     11       11  

Other liabilities (note 5)

     732       2,948  
                

Total long-term liabilities

     834       7,460  

Liabilities subject to compromise (note 18)

     7,691       —    
                

Total liabilities

     11,738       11,966  
                

Guarantees, commitments, contingencies and subsequent events (notes 12, 14, 20 and 21, respectively)

    
SHAREHOLDERS’ DEFICIT     

Common shares, without par value—Authorized shares: unlimited; Issued and outstanding shares: 498,020,147 and 497,893,086 as of March 31, 2009 and December 31, 2008, respectively.

     35,596       35,593  

Additional paid-in capital

     3,645       3,547  

Accumulated deficit

     (42,872 )     (42,362 )

Accumulated other comprehensive loss

     (829 )     (729 )
                

Total Nortel Networks Corporation shareholders’ deficit

     (4,460 )     (3,951 )

Noncontrolling interests

     825       822  
                

Total shareholders’ deficit

     (3,635 )     (3,129 )
                

Total liabilities and shareholders’ deficit

   $ 8,103     $ 8,837  
                

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

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009—note 2)

Condensed Combined and Consolidated Statement of Cash Flows (unaudited)

(Millions of U.S. Dollars)

 

     Three months ended March 31,  
         2009             2008      

Cash flows from (used in) operating activities

    

Net loss attributable to Nortel Networks Corporation

   $ (507 )   $ (138 )

Adjustments to reconcile net loss to net cash from (used in) operating activities:

    

Amortization and depreciation

     82       82  

Goodwill impairment

     48       —    

Non-cash portion of cost reduction activities

     5       2  

Equity in net loss (earnings) of associated companies—net of tax

     —         (1 )

Share-based compensation expense

     101       21  

Deferred income taxes

     4       12  

Pension and other accruals

     46       32  

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

     (14 )     6  

Income attributable to noncontrolling interests—net of tax

     26       78  

Reorganization items—non cash

     42       —    

Other—net

     22       (25 )

Change in operating assets and liabilities

     347       (329 )
                

Net cash from (used in) operating activities

     202       (260 )
                

Cash flows from (used in) investing activities

    

Expenditures for plant and equipment

     (12 )     (51 )

Proceeds on disposals of plant and equipment

     1       —    

Change in restricted cash and cash equivalents

     (55 )     18  

Decrease in short and long-term investments

     24       —    

Acquisitions of investments and businesses—net of cash acquired

     —         (29 )

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

     24       18  
                

Net cash used in investing activities

     (18 )     (44 )
                

Cash flows from (used in) financing activities

    

Dividends paid by subsidiaries to noncontrolling interests

     —         (11 )

Increase in notes payable

     11       28  

Decrease in notes payable

     (55 )     (25 )

Repayments of capital leases obligations

     (4 )     (6 )
                

Net cash used in financing activities

     (48 )     (14 )
                

Effect of foreign exchange rate changes on cash and cash equivalents

     (54 )     9  
                

Net increase (decrease) in cash and cash equivalents

     82       (309 )

Cash and cash equivalents at beginning of the period

     2,397       3,532  
                

Cash and cash equivalents at end of the period

   $ 2,479     $ 3,223  
                

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

 

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NORTEL NETWORKS CORPORATION

(Under Creditor Protection Proceedings as of January 14, 2009—note 2)

Notes to Condensed Combined and Consolidated Financial Statements (unaudited)

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

1. Basis of presentation

Nortel Networks Corporation

Nortel Networks Corporation (“Nortel” or “NNC”) is a global supplier of end-to-end networking products and solutions serving both service providers and enterprise customers. Nortel’s technologies span access and core networks and support multimedia and business-critical applications. Nortel’s networking solutions consist of hardware, software and services. Nortel designs, develops, engineers, markets, sells, licenses, installs, services and supports these networking solutions worldwide.

Nortel Networks Limited (“NNL”) is Nortel’s principal direct operating subsidiary and its results are consolidated into Nortel’s results. Nortel holds all of NNL’s outstanding common shares but none of its outstanding preferred shares. NNL’s preferred shares are reported in noncontrolling interests in the condensed combined and consolidated balance sheets and any dividends which may be paid on preferred shares are reported in income attributable to noncontrolling interests in the condensed statements of operations.

Combined and Consolidated Financial Statements

The financial statements as at December 31, 2008 and for the three months ended March 31, 2008 have been presented on a consolidated basis. After consideration of the guidance available in Statement of Financial Accounting Standards (“SFAS”) No. 94 “Consolidation of All Majority-Owned Subsidiaries”, American Institute of Certified Public Accountants Statement of Position 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” (“SOP 90-7”) and SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements”, the financial statements as at and for the three months ended March 31, 2009 have been presented on a combined and consolidated basis.

SOP 90-7, which is applicable to companies that have filed petitions under applicable bankruptcy code provisions, generally does not change the manner in which financial statements are prepared. However, it does require that the financial statements for periods subsequent to the filing of an applicable bankruptcy petition distinguish transactions and events that are directly associated with a reorganization from the ongoing operations of the business. For this reason, Nortel’s revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the Creditor Protection Proceedings (as defined in note 2) must be reported separately as reorganization items in the statements of operations beginning in the quarter ended March 31, 2009. The balance sheets must distinguish pre-petition liabilities subject to compromise from both those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, reorganization items must be disclosed separately in the statements of cash flows. Nortel adopted SOP 90-7 effective on January 14, 2009 and has segregated those items outlined above for all reporting periods subsequent to such date.

As further described in note 2, on January 14, 2009 Nortel and certain of its subsidiaries in Canada, the U.S., and in certain Europe, Middle East and Africa (“EMEA”) countries filed for creditor protection under the relevant jurisdictions of Canada, the U.S., the U.K. and subsequently in Israel. Notwithstanding these filings, other than with respect to the EMEA subsidiaries which filed for creditor protection (the EMEA Debtors, as defined in note 2), Nortel continues to exercise control over its subsidiaries located in Canada, the U.S., Central and Latin America (CALA), Asia, and EMEA that are not included in the U.K. Administration Proceedings (as defined in note 2), and these condensed financial statements are prepared on a consolidated basis with respect to those subsidiaries. However, as the U.K Administrators (as defined in note 2) exhibit certain elements of control

 

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over the EMEA Debtors that are subject to the U.K. Administration Proceedings particularly with respect to the transfer of cash between legal entities (especially across jurisdictions), the potential sale of certain assets, and certain employee related matters, Nortel’s ability to exercise certain elements of control has been inhibited. Based on its review of the applicable accounting guidance, Nortel concluded that as it does not have all elements of control over the EMEA Debtors, it is precluded from consolidating such subsidiaries in these condensed financial statements.

Nortel has determined that it is appropriate to prepare combined financial statements, instead of preparing separate financial statements, including the EMEA Debtors, as all the EMEA Debtors were deemed to be under common management with Nortel and its consolidated subsidiaries. Nortel considered several factors in assessing common management, including: (i) the intellectual property (IP) used by the EMEA Debtors is substantially owned by NNL and the EMEA Debtors’ business cannot operate without such IP; (ii) Nortel continues to operate on a business segment basis that does not for purposes of this analysis align with legal entities, requiring the businesses to operate across regions consistent with its practice prior to the Creditor Protection Proceedings (as defined in note 2); (iii) the U.K. Administrators’ indication that they will work closely, as disclosed in the U.K. Administrator’s Statement of Proposals (February 2009), with Nortel, the Canadian Monitor and the U.S. Creditors’ Committee (each as defined in note 2), in order to facilitate the Creditor Protection Proceedings; and (iv) management of Nortel and its consolidated entities generally continues to make the significant hiring, termination, compensation, operational (including contracting), and budgeting decisions in working with the U.K. Administrators.

In accordance with SFAS 160, the EMEA Debtors were deconsolidated prior to being combined with no impact on these condensed financial statements as it was not determinable that the carrying values of the net liabilities differed materially from their estimated fair values and, due to Nortel and its subsidiaries continuing involvement with the EMEA Debtors including NNL’s guarantee of the U.K. pension liability (see note 2), the net liabilities should continue to be included in the condensed financial statements.

In preparing the combined financial statements, intercompany transactions and profits or losses have been eliminated, and noncontrolling interests, foreign operations and income taxes have been treated in the same manner as they have been for consolidated financial statement purposes.

Basis of Presentation and Going Concern Issues

The unaudited condensed combined and consolidated financial statements do not include all information and notes required by U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) in the preparation of annual combined and consolidated financial statements. The accounting policies used in the preparation of the unaudited condensed combined and 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, 2008, except as discussed above and in notes 3 and 4. The condensed consolidated balance sheet as of December 31, 2008 is derived from the December 31, 2008 audited consolidated financial statements. Although Nortel is headquartered in Canada, the unaudited condensed combined and consolidated financial statements are expressed in U.S. Dollars as the greater part of Nortel’s financial results and net assets 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 combined and 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, 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, contingencies and pre-petition liabilities.

 

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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 months ended March 31, 2009 are not necessarily indicative of financial results for the full year or for any other quarter. The unaudited condensed combined and consolidated financial statements should be read in conjunction with Nortel’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the U.S. Securities and Exchange Commission (“SEC”) and Canadian securities regulatory authorities (“2008 Annual Report”).

The commencement of the Creditor Protection Proceedings raises substantial doubt as to whether Nortel will be able to continue as a going concern. The unaudited combined and consolidated financial statements have been prepared using the same U.S. GAAP and the rules and regulations of the SEC as applied by Nortel prior to the Creditor Protection Proceedings, except as disclosed above and in note 3. While the Debtors (as defined in note 2) have filed for and been granted creditor protection, the unaudited condensed combined and consolidated financial statements continue to be prepared using the going concern basis, which assumes that Nortel will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. The Creditor Protection Proceedings provide Nortel with a period of time to, among other things, stabilize its operations and financial condition. However, it is not possible to predict the outcome of these proceedings and, as such, the realization of assets and discharge of liabilities are each subject to significant uncertainty. Further, it is not possible to predict whether the actions taken will result in improvements to Nortel’s financial condition sufficient to allow it to continue as a going concern. If the going concern basis is not appropriate, adjustments will be necessary to the carrying amounts and/or classification of Nortel’s assets and liabilities. Further, a formal court-approved plan of reorganization (also called a plan of compromise or arrangement) could materially change the carrying amounts and classifications reported in the unaudited condensed combined and consolidated financial statements.

The unaudited condensed combined and consolidated financial statements do not purport to reflect or provide for the consequences of the Creditor Protection Proceedings. In particular, such unaudited condensed combined and consolidated financial statements do not purport to show: (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (b) as to pre-petition liabilities, all amounts that may be allowed for claims or contingencies, or the status and priority thereof, or the amounts at which they may ultimately be settled; (c) as to shareholders’ accounts, the effect of any changes that may be made in Nortel’s capitalization; or (d) as to operations, the effect of any changes that may be made in Nortel’s business.

Comparative figures

Certain 2008 figures in the unaudited condensed combined and consolidated financial statements have been reclassified to conform to Nortel’s current presentation.

Recent accounting pronouncements

 

(i) In April 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 157-4, “Determining Fair Value when the Volume and Level of Activity for the Asset or Liability have Significantly Decreased and Identifying Transactions that are not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides additional guidance on determining fair value for a financial asset when the volume or level of activity for that asset or liability has significantly decreased and also assists in identifying circumstances that indicate a transaction is not orderly. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary. FSP FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009 and will be applied prospectively. Nortel plans to adopt the provisions of FSP FAS 157-4 on April 1, 2009. Nortel is currently assessing the impact of adoption of FSP FAS 157-4.

 

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(ii) In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other Than Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”). FSP FAS 115-2 and FAS 124-2 provide guidance on determining whether the holder of an investment in a debt or equity security for which changes in fair value are not regularly recognized in earnings (such as securities classified as held-to-maturity or available-for-sale) should recognize a loss in earnings when the investment is impaired. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual reporting periods ending after June 15, 2009. Nortel plans to adopt the provisions of FSP FAS 115-2 and FAS 124-2 on April 1, 2009 and is currently assessing the impact of adoption.

2. Creditor protection proceedings

At this point in the Creditor Protection Proceedings, Nortel is focused on maximizing value for its stakeholders, including creditors, customers and employees, as it continues to work on the evaluation of its businesses, namely Carrier Networks (“CN”) (which includes Wireless Networks and Carrier VoIP and Applications Solutions (CVAS)), Enterprise Solutions (“ES”), Metro Ethernet Networks (“MEN”) and LG-Nortel Co. Ltd., the joint-venture between LG electronics Inc. (“LGE”) and Nortel, (“LGN”). Discussions are taking place with various external parties, however Nortel continues to evaluate its restructuring alternatives. Work is underway to evaluate the ultimate path forward for its businesses. To provide maximum flexibility Nortel is also taking the appropriate steps to complete the move to standalone businesses.

CCAA Proceedings

On January 14, 2009 (“Petition Date”), Nortel, NNL and certain other Canadian subsidiaries (“Canadian Debtors”) obtained an initial order from the Ontario Superior Court of Justice (“Canadian Court”) for creditor protection for 30 days, pursuant to the provisions of the Companies’ Creditors Arrangement Act (“CCAA”), which has since been extended to July 30, 2009 and is subject to further extension by the Canadian Court (“CCAA Proceedings”). There is no guarantee that the Canadian Debtors will be able to obtain court orders or approvals with respect to motions the Canadian Debtors may file from time to time to extend further the applicable stays of actions and proceedings against them. Pursuant to the initial order, the Canadian Debtors received approval to continue to undertake various actions in the normal course in order to maintain stable and continuing operations during the CCAA Proceedings.

Under the terms of the initial order, Ernst & Young Inc. was named as the court-appointed monitor (“Canadian Monitor”) under the CCAA Proceedings. The Canadian Monitor has reported and will continue to report to the Canadian Court from time to time on the Canadian Debtors’ financial and operational position and any other matters that may be relevant to the CCAA Proceedings. In addition, the Canadian Monitor may advise and, to the extent required, assist the Canadian Debtors on matters relating to the Creditor Protection Proceedings.

As a consequence of the CCAA Proceedings, generally, all actions to enforce or otherwise effect payment or repayment of liabilities of any Canadian Debtor preceding the Petition Date and substantially all pending claims and litigation against the Canadian Debtors and their officers and directors have been stayed until July 30, 2009, or such further date as may be ordered by the Canadian Court. In addition, the CCAA Proceedings have been recognized by the United States Bankruptcy Court for the District of Delaware (“U.S. Court”) as “foreign proceedings” pursuant to the provisions of Chapter 15 of the U.S. Bankruptcy Code, giving effect in the U.S., to the stay granted by the Canadian Court. A cross-border court to court protocol has also been approved by the U.S. Court and the Canadian Court. This protocol provides the U.S. Court and the Canadian Court with a framework for the coordination of the administration of the Chapter 11 Proceedings (as defined below) and the CCAA Proceedings on matters of concern to both courts.

In connection with the Creditor Protection Proceedings (as defined below), the Canadian Debtors have granted a charge against some or all of Nortel’s and their assets and any proceeds from and sales thereof, as follows and in the following priority:

 

   

First, the administration charge, in an amount not to exceed CAD$5 in favor of the Canadian Monitor and its counsel and counsel to the Canadian Debtors against all of the property of the Canadian Debtors, to secure payment of professional fees and disbursements before and after the Petition Date;

 

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Second, the Carling facility charges, in favor of Nortel Networks Inc. (“NNI”) as security for amounts owed by NNL and Nortel Networks Technology Corporation (“NNTC”) to NNI with respect to a post-Petition Date intercompany revolving loan agreement (“NNI Loan Agreement”), against the fee simple interest of NNTC and the leasehold interest of NNL in the real property located at 3500 Carling Avenue, Labs 1-10, Ottawa, Ontario, such charge not to exceed the amount of any such loan plus related interest and fees;

 

   

Third, a charge, in favor of EDC (as defined below) against all of the property of the Canadian Debtors as security for new support provided by EDC to NNL under the EDC Support Facility (as defined below), but excluding any renewals or extensions after April 24, 2009 in respect of support outstanding as of the Petition Date;

 

   

Fourth, the directors’ charge, against all property of the Canadian Debtors in an amount not exceeding CAD$90, as security for their obligation to indemnify their respective directors and officers for all claims that may be made against them relating to any failure of the Canadian Debtors to comply with certain statutory payment and remittance obligations arising during the CCAA Proceedings, and legal fees and expenses of their counsel in connection with the CCAA Proceedings;

 

   

Fifth, in addition to the Carling facility charges, a charge on the property of each of the Canadian Debtors, in favor of NNI as security for each Canadian Debtors’ obligations under the NNI Loan Agreement (subject to the requirement that such charge shall only be enforceable pending further order of the Canadian Court); and

 

   

Sixth, the intercompany charge, in favor of any U.S. Debtor (as defined below) that has made or may make a post-Petition Date intercompany loan or other transfer (including of goods or services) to one or more of the Canadian Debtors (including amounts owed by NNL to NNI on the Petition Date under a certain intercompany loan agreement) against the property of the Canadian Debtor that receives such loan or transfer, to secure payments or repayments relating thereto, such charge not to exceed the amount of any such loan or transferred goods or services, plus related interest and fees. The intercompany charge also covers amounts owing in respect of post-Petition Date trade with the EMEA Debtors and any amounts advanced by NNL to NNTC following the Petition Date.

Chapter 11 Proceedings

Also on the Petition Date, NNI, Nortel Networks Capital Corporation (“NNCC”) and certain other of Nortel’s U.S. subsidiaries (“U.S. Debtors”) filed voluntary petitions under Chapter 11 with the U.S. Court (“Chapter 11 Proceedings”). The U.S. Debtors received approval from the U.S. Court for a number of motions enabling them to continue to operate their businesses generally in the ordinary course. Among other things, the U.S. Debtors received approval to continue paying employee wages and certain benefits in the ordinary course; to generally continue their cash management system, including approval of a revolving loan agreement between NNI as lender and NNL as borrower with an initial advance to NNL of $75, to support NNL’s ongoing working capital and general corporate funding requirements; and to continue honoring customer obligations and paying suppliers for goods and services received on or after the Petition Date.

As required under the U.S. Bankruptcy Code, on January 22, 2009, the United States Trustee for the District of Delaware appointed an official committee of unsecured creditors, which currently includes The Bank of New York Mellon, Flextronics Corporation, Airvana, Inc., Pension Benefit Guaranty Corporation and Law Debenture Trust Company of New York (“U.S. Creditors’ Committee”). The U.S. Creditors’ Committee has the right to be heard on all matters that come before the U.S. Court with respect to the U.S. Debtors. There can be no assurance that the U.S. Creditors’ Committee will support the U.S. Debtors’ positions on matters to be presented to the U.S. Court. In addition, a group purporting to hold substantial amounts of Nortel’s publicly traded debt has organized (“Bondholder Group”). Nortel’s management and the Monitor have met with the Bondholder Group and its advisors to provide status updates and share information with them that has been shared with other major stakeholders. Disagreements between the Debtors and the U.S. Creditors’ Committee and the Bondholder Group could protract and negatively impact the Creditor Protection Proceedings (as defined below), and the Debtors’ ability to operate.

 

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As a consequence of the commencement of the Chapter 11 Proceedings, generally, all actions to enforce or otherwise effect payment or repayment of liabilities of any U.S. Debtor preceding the Petition Date and substantially all pending claims and litigation against the U.S. Debtors have been automatically stayed for the pendency of the Chapter 11 Proceedings (absent any court order lifting the stay). In addition, the U.S. Debtors applied for and obtained an order in the Canadian Court recognizing the Chapter 11 Proceedings in the U.S. as “foreign proceedings” in Canada and giving effect, in Canada, to the automatic stay under the U.S. Bankruptcy Code.

U.K. Administration Proceedings

Also on the Petition Date, certain of Nortel’s EMEA subsidiaries (“EMEA Debtors”) made consequential filings and each obtained an administration order from the English High Court of Justice (“English Court”) under the Insolvency Act 1986 (“U.K. Administration Proceedings”). The applications were made by the EMEA Debtors under the provisions of the European Union’s Council Regulation (EC) No 1346/2000 on creditor protection proceedings and on the basis that each EMEA Debtor’s center of main interests is in England. Under the terms of the orders, a representative of Ernst & Young LLP (in the U.K.) and a representative of Ernst & Young Chartered Accountants (in Ireland) were appointed as joint administrators with respect to the EMEA Debtor in Ireland, and representatives of Ernst & Young LLP were appointed as joint administrators for the other EMEA Debtors (collectively, “U.K. Administrators”) to manage the EMEA Debtors’ affairs, business and property under the jurisdiction of the English Court and in accordance with the applicable provisions of the Insolvency Act 1986. The administration orders provide for a moratorium during which creditors may not, without leave of the English Court or consent of the U.K. Administrators, wind up the company, enforce security, or commence or progress legal proceedings. All of Nortel’s operating EMEA subsidiaries except those in the following countries are included in the U.K. Administration Proceedings: Nigeria, Russia, Ukraine, Israel, Norway, Switzerland, South Africa and Turkey, as well, certain of Nortel’s Israeli subsidiaries (“Israeli Debtors”) have commenced a separate creditor protection process in Israel (“Israeli Proceedings”) and currently a court-approved stay of proceedings is in place until May 27, 2009.

The Canadian Debtors, U.S. Debtors, EMEA Debtors and Israeli Debtors are together referred to as the Debtors and the CCAA Proceedings, Chapter 11 Proceedings, U.K. Administration Proceedings and Israeli Proceedings are together referred to as the Creditor Protection Proceedings.

Business Operations

During the Creditor Protection Proceedings, the businesses of the Debtors continue to operate under the jurisdictions and orders of the applicable courts and in accordance with applicable legislation.

Under the U.S. Bankruptcy Code, the U.S. Debtors may assume, assume and assign, or reject certain executory contracts including unexpired leases, subject to the approval of the U.S. Court and certain other conditions. Pursuant to the initial order of the Canadian Court, the Canadian Debtors are permitted to repudiate any arrangement or agreement, including real property leases. Any reference to any such agreements or instruments and to termination rights or a quantification of Nortel’s obligations under any such agreements or instruments is qualified by any overriding rejection, repudiation or other rights the Debtors may have as a result of or in connection with the Creditor Protection Proceedings. The administration orders granted by the English Court do not give any similar unilateral rights to the U.K. Administrators. The U.K. Administrators decide whether an EMEA Debtor should perform under a contract on the basis of whether it is in the interests of the administration to do so. Claims may arise as a result of a Debtor rejecting or repudiating any contract or arrangement, which claims would usually be unsecured. Since the Petition Date, the Debtors have rejected or repudiated various contracts, including real property leases and commercial agreements. The Debtors will continue to review other contracts throughout the Creditor Protection Proceedings.

Evaluation of Businesses

Nortel continues to evaluate its various operations in consultation with its business and financial advisors with a view to maximizing value for it stakeholders, including creditors, customers and employees. In this

 

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context, Nortel decided to discontinue its mobile Worldwide Interoperability for Microwave Access (“WiMAX”) business and sold its Layer 4-7 data portfolio. Further, Nortel has significantly reduced its investment in its Carrier Ethernet switch/router portfolio, while continuing to ship products and support its installed base of Carrier Ethernet customers. The Creditor Protection Proceedings may result in additional sales or divestitures, but Nortel can provide no assurance that it will be able to complete any sale or divestiture on acceptable terms or at all. On February 18, 2009, the U.S. Court approved procedures for the sale or abandonment by the U.S. Debtors of assets with a de minimis value. The Canadian Debtors and EMEA Debtors can generally take similar actions with the approval of the Canadian Monitor and the U.K. Administrators, respectively. As Nortel continues to evaluate its businesses, it will consult with the Canadian Monitor, the U.K. Administrators and the U.S. Creditors’ Committee and other stakeholders, and any plans may eventually be subject to the approval of affected creditors and the relevant courts. There can be no assurance that any such plans, or a plan of reorganization in the U.S., or a plan of compromise or arrangement in Canada, will be developed, confirmed or approved, where required, by any of the relevant courts or affected creditors, or that any such plan will be implemented successfully.

Nortel is currently undergoing an in-depth analysis to assess the strategic and economic value of several of its subsidiaries, in particular those that are incurring losses and require financial assistance or support in order to carry on business. In light of this analysis, Nortel has started making decisions to cease operations in certain countries that are no longer considered strategic or material to our business or where such losses cannot be supported or justified on an ongoing basis.

Export Development Canada Support Facility; Other Contracts & Debt Instruments

Effective January 14, 2009, NNL entered into an agreement with Export Development Canada (“EDC”) to permit continued access by NNL to the EDC Support facility (“EDC Support Facility”) for an interim period to February 13, 2009, for up to $30 of support based on its then-estimated requirements over the period. The EDC Support Facility provides for the issuance of support in the form of guarantee bonds or guarantee type documents issued to financial institutions that issue letters of credit or guarantee, performance or surety bonds, or other instruments in support of Nortel’s contract performance. EDC subsequently agreed to extend this interim period to May 1, 2009. Under an amending agreement dated April 24, 2009, this interim period was further extended to July 30, 2009. As well, the amending agreement clarified that going forward, the charge over certain of Nortel’s assets in favor of EDC will extend only to new support provided after January 14, 2009 and rollovers or extensions of pre-existing support made before April 14, 2009. Nortel continues to have ongoing discussions with EDC and potential fronting institutions which issue performance bonds to put in place a more permanent performance bonding facility.

Nortel’s filings under Chapter 11 and the CCAA constituted events of default or otherwise triggered repayment obligations under the instruments governing substantially all of the indebtedness issued or guaranteed by NNC, NNL, NNI and NNCC. In addition, Nortel may not be in compliance with certain other covenants under indentures, the EDC Support Facility and other debt or lease instruments, and the obligations under those agreements may have been accelerated. Nortel believes that any efforts to enforce such payment obligations against the U.S. Debtors are stayed as a result of the Chapter 11 Proceedings. Although the CCAA does not provide an automatic stay, the Canadian Court has granted a stay to the Canadian Debtors that currently extends to July 30, 2009. Pursuant to the U.K. Administration Proceedings, a moratorium has commenced during which creditors may not, without leave of the English Court or consent of the U.K. Administrators, enforce security, or commence or progress legal proceedings.

The Creditor Protection Proceedings may have also constituted events of default under other contracts and leases of the Debtors. In addition, the Debtors may not be in compliance with various covenants under other contracts and leases. Depending on the jurisdiction, actions taken by counterparties or lessors based on such events of default and other breaches may be unenforceable as a result of the Creditor Protection Proceedings.

 

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In addition, the Creditor Protection Proceedings may have caused, directly or indirectly, defaults or events of default under the debt instruments and/or contracts and leases of certain of Nortel’s non-Debtor entities. These events of default (or defaults that become events of default) could give counterparties the right to accelerate the maturity of this debt or terminate such contracts or leases.

Flextronics

On January 14, 2009, Nortel announced that NNL had entered into an amendment to arrangements with a major supplier, Flextronics Telecom Systems, Ltd. (“Flextronics”). Under the terms of the amendment, NNL agreed to commitments to purchase $120 of existing inventory by July 1, 2009 and to make quarterly purchases of other inventory, and to terms relating to payment and pricing. Flextronics has notified Nortel of its intention to terminate certain other arrangements upon 180 days’ notice (in July 2009) pursuant to the exercise by Flextronics of its contractual termination rights, while the other arrangements between the parties will continue in accordance with their terms. Nortel believes that its arrangements with Flextronics are subject to the initial order granted by the Canadian Court that stays its suppliers from terminating their agreements with Nortel. Nortel continues to work with Flextronics throughout this process and continues to discuss various aspects of the January 14, 2009 agreement and other aspects of the relationship.

Workforce Reductions; Employee Compensation Program Changes

On February 25, 2009, Nortel announced a workforce reduction plan. Under this plan, Nortel intends to reduce its global workforce by approximately 5,000 net positions. Nortel has commenced and expects to continue to implement these reductions over the next several months, in accordance with local country legal requirements (see note 9 for additional information on Nortel’s cost reduction activities). Given the Creditor Protection Proceedings, Nortel has discontinued all remaining activities under its previously announced restructuring plans as of the Petition Date. Nortel expects to take further, ongoing workforce and other cost reduction actions as it works through the Creditor Protection Proceedings.

Nortel also announced on February 25, 2009 several changes to its employee compensation programs. Upon the recommendation of management, Nortel’s Board of Directors approved no payment of bonuses under the Nortel Annual Incentive Plan (“AIP”) for 2008. Nortel is continuing its AIP in 2009 for all eligible full- and part-time employees. The plan has been modified to permit quarterly rather than annual award determinations and payouts, if any. This will provide a more immediate incentive for employees upon the achievement of critical shorter-term corporate performance objectives, including specific operational metrics in support of customer service levels, as Nortel works through the Creditor Protection Proceedings. Where required, Nortel has obtained court approvals for retention and incentive compensation plans for certain key eligible employees deemed essential to the business during the Creditor Protection Proceedings and Nortel has since implemented such plans. On March 20, 2009, Nortel obtained Canadian Court approval to terminate the Nortel Networks Corporation Change in Control Plan.

On February 27, 2009, Nortel obtained Canadian Court approval to terminate its equity-based compensation plans (the Nortel 2005 Stock Incentive Plan, As Amended and Restated (“2005 SIP”), the Nortel Networks Corporation 1986 Stock Option Plan, As Amended and Restated (“1986 Plan”) and the Nortel Networks Corporation 2000 Stock Option Plan (“2000 Plan”)) and certain equity plans assumed in prior acquisitions, including all outstanding equity under these plans (stock options, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and performance stock units (“PSUs”)), whether vested or unvested. Nortel sought this approval given the decreased value of NNC common shares and the administrative and associated costs of maintaining the plans to us as well as the plan participants. See note 17 for additional information about Nortel’s share-based compensation plans.

 

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Directors’ and Officers’ Compensation and Indemnification

The Canadian Court has ordered the Canadian Debtors to indemnify their respective directors and officers for all claims that may be made against them relating to any failure of the Canadian Debtors to comply with certain statutory payment and remittance obligations arising during the CCAA Proceedings. The Canadian Court has also granted a charge against all property of the Canadian Debtors, in the aggregate amount not exceeding CAD $90, as security for such indemnities and related legal fees and expenses.

In addition, in conjunction with the Creditor Protection Proceedings, NNC established a directors’ and officers’ trust (“D&O Trust”) in the amount of approximately CDN$12. The purpose of the D&O Trust is to provide a trust fund for the payment of liability claims (including defense costs) that may be asserted against individuals who serve as directors and officers of NNC, or as directors and officers of other entities at NNC’s request (such as subsidiaries and joint venture entities), by reason of that association with NNC or other entity, to the extent that such claims are not paid or satisfied out of insurance maintained by NNC and NNC is unable to indemnify the individual. Such liability claims would include claims for unpaid statutory payment or remittance obligations of NNC or such other entities for which such directors and officers have personal statutory liability but will not include claims for which NNC is prohibited by applicable law from providing indemnification to such directors or officers. The D&O Trust also may be drawn upon to maintain directors’ and officers’ insurance coverage in the event NNC fails or refuses to do so. The D&O Trust will remain in place until the later of December 31, 2015 or three years after all known actual or potential claims have been satisfied or resolved, at which time any remaining trust funds will revert to NNC.

As part of the relief sought in the CCAA Proceedings, Nortel requested entitlement to pay the directors their compensation in cash on a current basis, notwithstanding any outstanding elections, during the period in which the directors continue as directors in the CCAA Proceedings. On the Petition Date, the Canadian Court granted an order providing that Nortel’s directors are entitled to receive remuneration in cash on a current basis at current compensation levels less an overall $25 thousand reduction notwithstanding the terms of, or elections made under, the Deferred Share Compensation Plans.

Decision on Mobile WiMAX Business and Alvarion Agreement

On January 29, 2009, Nortel announced that it has decided to discontinue its mobile WiMAX business and end its joint agreement with Alvarion Ltd., originally announced in June 2008. Nortel is working closely with Alvarion and its mobile WiMAX customers to transition and/or settle their contractual obligations to help ensure that either ongoing support commitments are met without interruption or alternative settlements are reached that mutually benefit Nortel and its customers. This decision has had no impact on Nortel’s business units other than CN.

Condensed Combined Debtors Financial Statements

The financial statements contained within this note have been prepared in accordance with the guidance of SOP 90-7 and represent the unaudited condensed combined financial statements for the Debtors. Such statements include separate columnar presentations for the Canadian Debtors, U.S. Debtors and EMEA Debtors to provide information that may be useful to the users of these financial statements. In addition, such presentation facilitates the combined presentation of the deconsolidated EMEA Debtors. Non-Debtor subsidiaries and affiliates are treated as non-consolidated affiliates in these financial statements and as such their net income (loss) is included as “Equity income (loss) from non-debtor subsidiaries, net of tax” in the statement of operations and their net assets are included as “Investments in non-Debtor subsidiaries” in the balance sheet.

Included in the accompanying Debtors’ financial statements is the EMEA Debtors’ balance sheet as of March 31, 2009, and statement of operations and cash flows for the three months ended March 31, 2009. The EMEA Debtors have been deconsolidated as of the Petition Date. See note 1 to the unaudited condensed combined and consolidated financial statements for further disclosure about the deconsolidation and combination of the EMEA Debtors’ accounts.

 

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Intercompany Transactions

Intercompany transactions and balances amongst the Debtors are included in each of the individual Debtor’s balance sheet, income statement and cash flow columns and have been eliminated in combination. At March 31, 2009, the Canadian Debtors have a negative investment in the EMEA Debtors’ underlying net liabilities which are recorded at their carrying values as it was not determinable that such carrying value differs materially from the estimated fair value. This negative investment account has been eliminated in combination. Intercompany transactions and balances with Nortel’s non –Debtor subsidiaries and affiliates have not been eliminated in the Debtors’ financial statements.

Guarantees

Included in the accompanying Canadian Debtors’ financial statement columns is an accrual of approximately $550 representing NNL’s best estimate of the probable claim for the guarantee of the EMEA Debtors’ unfunded pension liability (“Pension Guarantee”). NNL has irrevocably and unconditionally guaranteed Nortel Networks UK Limited’s punctual performance under the U.K. Defined Benefit Pension Plan funding agreement. Although some guarantee exposures are redundant to liabilities elsewhere in the Debtors’ financial statements, Nortel has recorded this accrual in accordance with SOP 90-7.

In addition, an accrual of $3,935 has been made in the U.S. Debtors financial statement columns for NNI’s guarantee of the NNC and NNL outstanding long–term debt arrangements. NNI has fully and unconditionally guaranteed the NNC and NNL issuances of the July 2006 Notes, the Convertible Notes and the 2016 Fixed Rate Notes issued May 2008 (each as defined in note 21). In addition, NNL has recognized $150 arising from a guarantee of long-term debt of NNCC. Collectively, these guarantees are the “Debt Guarantees”. Although some guarantee exposures are redundant to liabilities recorded elsewhere in the Debtors’ financial statements, Nortel has recorded this accrual in accordance with SOP 90-7.

The Pension Guarantee and Debt Guarantees have been recorded as liabilities subject to compromise and reorganization expenses in the respective financial statement columns and have been eliminated in combination. To the extent that information available in the future indicates a difference from the recognized amounts, the provision will be adjusted.

Contractual Interest Expense on Outstanding Long-Term Debt

During the three months ended March 31, 2009, Nortel has continued to accrue for interest expense of $70 in its normal course of operations related to debt issued by NNC or NNL in Canada based on the expectation that it will be a permitted claim under the Creditor Protection Proceedings. However, in accordance with SOP 90-7, interest expense in the U.S. incurred post-Petition Date is not recognized, as a result interest payable on debt issued by the U.S. Debtors, including NNI, has not been accrued in the accompanying unaudited condensed combined and consolidated financial statements. During the pendency of the Creditor Protection Proceedings Nortel generally has not and does not expect to make payments to satisfy the interest obligations of the Debtors.

Cash Restrictions

The movement of cash to and from each of the Debtors is permitted for transactions conducted in the normal course, but is restricted for other purposes such as intercompany cash advances and loans, except where such intercompany advances and loans are permitted by the U.S. Court and Canadian Court and/or the U.K. Administrators.

 

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CONDENSED COMBINED STATEMENT OF OPERATIONS (unaudited)

(Millions of U.S. Dollars)

 

     Period from January 1, 2009 to March 31, 2009  
     Canada     U.S.     EMEA     Eliminations     Total  

Revenues

   $ 455     $ 854     $ 358     $ (316 )   $ 1,351  

Cost of revenues

     171       748       246       (316 )     849  
                                        

Gross profit

     284       106       112       —         502  
                                        

Selling, general and administrative expense

     134       311       155       (27 )     573  

Research and development expense

     160       145       26       —         331  

Other charges

     (2 )     —         —         —         (2 )

Gain on sales of businesses and assets

     (7 )     (5 )     (4 )     —         (16 )

Other operating expense (income)—net

     —         3       1       —         4  
                                        

Operating earnings (loss)

     (1 )     (348 )     (66 )     27       (388 )

Other income (expense)—net

     (58 )     199       (18 )     (198 )     (75 )

Interest expense

          

Long-term debt

     (70 )     (3 )     (1 )     —         (74 )

Other

     (2 )     (1 )     —         2       (1 )
                                        

Loss from operations before reorganization items, income taxes and equity in net earnings of associated companies

     (131 )     (153 )     (85 )     (169 )     (538 )

Reorganization items—net

     (731 )     (3,917 )     (44 )     4,637       (55 )
                                        

Loss from operations before income taxes and equity in net earnings of associated companies

     (862 )     (4,070 )     (129 )     4,468       (593 )

Income tax expense

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

Loss from operations before equity in net earnings of associated companies

     (866 )     (4,072 )     (131 )     4,468       (601 )

Equity in net earnings of associated companies—net of tax

     244       —         —         (267 )     (23 )
                                        

Net loss attributable to Debtors, including noncontrolling interests

     (622 )     (4,072 )     (131 )     4,201       (624 )
                                        

Equity income (loss) from non-Debtor subsidiaries—net of tax

     115       (80 )     17       65       117  

Earnings attributable to noncontrolling interests in Debtors

     —         —         —         —         —    
                                        

Net loss attributable to Nortel Networks Corporation

   $ (507 )   $ (4,152 )   $ (114 )   $ 4,266     $ (507 )
                                        

 

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CONDENSED COMBINED BALANCE SHEET (unaudited)

(Millions of U.S. Dollars)

 

     March 31, 2009  
     Canada     U.S.     EMEA     Eliminations     Total  
ASSETS           

Current assets

          

Cash and cash equivalents

   $ 218     $ 678     $ 694     $ —       $ 1,590  

Short-term investments

     —         23       —         —         23  

Restricted cash and cash equivalents

     49       9       26       —         84  

Accounts receivable—net:

          

Third parties

     114       480       308       —         902  

Non-Debtor subsidiaries and inter-Debtor

     808       629       49       (1,039 )     447  

Inventories—net

     60       338       495       —         893  

Other current assets

     101       124       99       —         324  
                                        

Total current assets

     1,350       2,281       1,671       (1,039 )     4,263  

Investments

     6       41       3       —         50  

Investments in non-Debtor subsidiaries

     1,998       89       (454 )     446       2,079  

Plant and equipment—net

     478       334       135       —         947  

Intangible assets—net

     2       24       10       —         36  

Deferred income taxes—net

     —         —         2       —         2  

Other assets

     126       55       95       —         276  
                                        

Total assets

   $ 3,960     $ 2,824     $ 1,462     $ (593 )   $ 7,653  
                                        
LIABILITIES AND SHAREHOLDERS’ DEFICIT           

Current liabilities not subject to compromise:

          

Trade and other accounts payable:

          

Third parties

   $ 76     $ 63     $ 54     $ (49 )   $ 144  

Non-Debtor subsidiaries and inter-Debtor

     210       56       65       (246 )     85  

Payroll and benefit-related liabilities

     80       164       74       —         318  

Contractual liabilities

     2       28       18       —         48  

Restructuring liabilities

     —         8       6       —         14  

Other accrued liabilities

     168       841       574       —         1,583  
                                        

Total current liabilities

     536       1,160       791       (295 )     2,192  

Long-term liabilities

          

Deferred income taxes—net

     —         —         1       —         1  

Other liabilities

     152       205       153       —         510  
                                        

Total long-term liabilities

     152       205       154       —         511  

Liabilities subject to compromise

     6,907       5,809       1,600       (5,731 )     8,585  
                                        

Total liabilities

     7,595       7,174       2,545       (6,026 )     11,288  
                                        

Total shareholders’ deficit of Debtors

     (4,176 )     (4,350 )     (1,083 )     5,433       (4,176 )

Noncontrolling interests in Debtors

     541       —         —         —         541  
                                        

Total shareholders’ deficit

     (3,635 )     (4,350 )     (1,083 )     5,433       (3,635 )
                                        

Total liabilities and shareholders’ deficit

   $ 3,960     $ 2,824     $ 1,462     $ (593 )   $ 7,653  
                                        

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

 

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CONDENSED COMBINED STATEMENT OF CASH FLOWS (unaudited)

(Millions of U.S. Dollars)

 

     Period from January 1, 2009 to March 31, 2009  
     Canada     U.S.     EMEA     Eliminations     Total  

Cash flows from (used in) operating activities

          

Net loss attributable to Debtors

   $ (507 )   $ (4,152 )   $ (114 )   $ 4,266     $ (507 )

Adjustments to reconcile net loss to net cash from (used in) operating activities:

          

Reorganization items—non cash

     725       3,916       38       (4,637 )     42  

Other adjustments

     (178 )     228       143       371       564  
                                        

Net cash from (used in) operating activities

     40       (8 )     67       —         99  
                                        

Cash flows from (used in) investing activities

          

Expenditures for plant and equipment

     (2 )     (4 )     (1 )     —         (7 )

Change in restricted cash and cash equivalents

     (18 )     (10 )     (26 )     —         (54 )

Decrease in short-term and long-term investments

     —         24       —         —         24  

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

     7       8       3       —         18  
                                        

Net cash from (used in) investing activities

     (13 )     18       (24 )     —         (19 )
                                        

Cash flows from (used in) financing activities

          

Decrease in notes payable

     —         —         (4 )     —         (4 )

Repayments of capital leases obligations

     —         (2 )     (1 )     —         (3 )
                                        

Net cash from (used in) financing activities

     —         (2 )     (5 )     —         (7 )
                                        

Net increase in cash and cash equivalents

     27       8       38       —         73  

Cash and cash equivalents at beginning of the period

     191       670       656       —         1,517  
                                        

Cash and cash equivalents at end of the period

   $ 218     $ 678     $ 694     $ —       $ 1,590  
                                        

3. Accounting changes

(a) Noncontrolling Interests

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 adopted the provisions of SFAS 160 on January 1, 2009. The adoption of SFAS 160 has resulted in the retrospective reclassification of noncontrolling interests (formerly referred to as minority interests) to shareholders’ deficit and related changes to the presentation of noncontrolling interests in the condensed combined and consolidated statements of operations. For the quarter ended March 31, 2009, the adoption of SFAS 160 did not impact the calculation of noncontrolling interests. These changes in measurement and presentation have not impacted the calculation of earnings (loss) per share.

(b) Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a single definition of fair value, a framework for measuring fair value and requires expanded disclosures about fair value measurements. Nortel partially adopted the provisions of SFAS 157 effective January 1, 2008. 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 was deferred to fiscal years beginning after December 15, 2008 in

 

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accordance with FSP SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP SFAS 157-2”). Nortel adopted the deferred portion of SFAS 157 on January 1, 2009. The adoption of the deferred portion of SFAS 157 did not have a material impact on Nortel’s results of operations and financial condition.

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

Effective for fiscal years ending after December 15, 2008, SFAS 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans” (“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 had historically measured the funded status of its significant plans on September 30. SFAS 158 provided two approaches for an employer to transition to a fiscal year end measurement date. Nortel 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 for the period between the earlier measurement date, being September 30, 2007 and the end of the fiscal year that the measurement date provisions are applied, being December 31, 2008 (exclusive of any curtailment or settlement gain or loss), are 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 ended December 31, 2008. The adoption 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 11.

(d) Derivative instruments disclosure

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 adopted the provisions of SFAS 161 on January 1, 2009. Nortel has provided the additional information required by SFAS 161 in note 13.

(e) Useful life of intangible assets

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 provides guidance with respect to estimating the useful lives of recognized intangible assets and requires additional disclosure related to the renewal or extension of the terms of recognized intangible assets. FSP FAS 142-3 is effective for fiscal years and interim periods beginning after December 15, 2008. Nortel adopted the provisions of FSP FAS 142-3 on January 1, 2009. The adoption of FSP FAS 142-3 did not have a material impact on Nortel’s results of operations, financial condition and disclosures.

(f) Collaborative arrangements

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 adopted the provisions of EITF 07-1 on January 1, 2009. The adoption of EITF 07-1 did not have a material impact on Nortel’s results of operations and financial condition.

(g) Determining whether an instrument is indexed to its own stock

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

 

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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 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 adopted the provisions of EITF 07-5 on January 1, 2009. The adoption of EITF 07-5 did not have a material impact on Nortel’s results of operations and financial condition.

4. Reorganization Items—net

Reorganization items represent the direct and incremental costs related to the Creditor Protection Proceedings such as revenues, expenses such as professional fees directly related to the process of reorganizing the Debtors, realized gains and losses, and provisions for losses resulting from the reorganization and restructuring of the business. The Debtors’ reorganization items consisted of the following:

 

     Three months ended
March 31, 2009
 

Professional fees (a)

   $ (57 )

Interest income (b)

     8  

Lease repudiation (c)

     22  

Key Executive Incentive Plan / Key Employee Retention Plan (d)

     (6 )

Other (e)

     (19 )
        

Total reorganization items—net

   $ (52 )
        

 

(a) Includes financial, legal, real estate and valuation services directly associated with the Creditor Protection Proceedings.
(b) Reflects interest earned due to the preservation of cash as a result of the Creditor Protection Proceedings.
(c) Nortel has rejected a number of leases, resulting in the recognition of non-cash gains and losses. Nortel may reject additional leases or other contracts in the future, which may result in recognition of material gains and losses.
(d) Relates to retention and incentive plans for certain key eligible employees deemed essential to the business during the Creditor Protection Proceedings.
(e) Includes other miscellaneous items directly related to the Creditor Protection Proceedings, such as loss on disposal of certain assets, revocation of a government grant and liquidated damages on early termination of a contract.

Nortel paid $10 relating to reorganization items in the three months ended March 31, 2009, attributable to $16 paid for professional fees partially offset by $6 received in interest income.

5. Condensed combined and consolidated financial statement details

The following tables provide details of selected items presented in the condensed combined and consolidated statements of operations and cash flows, and the condensed combined and consolidated balance sheets. For further information with respect to the accounting policies used in the preparation of the condensed combined and consolidated financial statement details below, refer to the 2008 Annual Report and notes 1 and 3 of this report.

 

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Condensed combined and consolidated statements of operations

Other operating expense (income)—net:

 

     Three months ended
March 31,
 
     2009     2008  

Royalty license income—net

   $ (6 )   $ (8 )

Litigation charges

     —         12  

Other—net

     (6 )     9  
                

Other operating expense (income)—net

   $ (12 )   $ 13  
                

Other expense—net:

 

     Three months ended
March 31,
 
     2009     2008  

Loss on sale or write down of investments

   $ (1 )   $ —    

Currency exchange losses—net

     (57 )     (19 )

Other—net

     (12 )     18  
                

Other expense—net

   $ (70 )   $ (1 )
                

Condensed combined and consolidated balance sheets

Short-term investments:

Short-term investments as of March 31, 2009 consisted of an investment having an original cost of $362 in the Reserve Primary Fund (“Fund”), a money market fund investment that was originally classified as cash and cash equivalents. Due to financial market conditions during the third quarter of 2008, which resulted in the suspension of trading in the Fund’s securities, an impairment of $11 was recorded during 2008 to reflect the decline in the net asset and deemed fair value of the Fund. Further, the Fund made redemptions on October 31, 2008, December 3, 2008 and February 20, 2009 of $184, $102 and $24, respectively.

On February 26, 2009, the Fund announced it would set aside $3,500, or 8.28 cents per share, in a special reserve that may be used to satisfy anticipated cost and expenses of the Fund, including legal and accounting fees, pending or threatened claims against the Fund, its officers and trustees, and claims for indemnification and other claims that could be made against the Fund’s assets. Fund distributions will be made pro rata from the Primary Fund’s assets up to 92 cents per share unless the board of trustees determines to increase the special reserve. Nortel’s pro rata share of the remainder of the announced per share distribution of 92 cents is $23, of which $16 has been redeemed subsequent to March 31, 2009 (note 21). As of March 31, 2009, Nortel has classified $23 of its investments in short-term investments and the remainder of $18 as long-term investments, as it is unable to assess the timing or amount of distributions which may be made from the special reserve.

Accounts receivable—net:

 

     March 31,
2009
    December 31,
2008
 

Trade receivables

   $ 1,511     $ 1,930  

Notes receivable

     3       3  

Contracts in process

     221       257  
                
     1,735       2,190  

Less: provision for doubtful accounts

     (43 )     (36 )
                

Accounts receivable—net

   $ 1,692     $ 2,154  
                

 

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Inventories—net:

 

     March 31,
2009
    December 31,
2008
 

Raw materials

   $ 251     $ 249  

Work in process

     5       4  

Finished goods

     746       721  

Deferred costs

     1,054       1,130  
                
     2,056       2,104  

Less: provision for inventories

     (520 )     (481 )
                

Inventories and long-term deferred costs—net

     1,536       1,623  

Less: long-term deferred costs (a)

     (117 )     (146 )
                

Inventories—net

   $ 1,419     $ 1,477  
                

 

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

Other current assets:

 

     March 31,
2009
   December 31,
2008

Prepaid expenses

   $ 124    $ 98

Income taxes recoverable

     99      107

Current investments

     22      21

Other

     244      229
             

Other current assets

   $ 489    $ 455
             

Investments:

Investments included, in part, $65 and $73 as of March 31, 2009 and December 31, 2008, 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 addition, Nortel classified its initial investment in auction rate securities as available-for-sale and current assets. In October 2008, Nortel entered into an agreement with the investment firm that sold Nortel a portion of its auction rate securities earlier in 2008 and as a result Nortel transferred these auction rate securities from available-for-sale to held-for-trading classification. Nortel currently holds $18 in auction rate securities, which have been recorded as $17 of trading securities as current assets and $1 as a long-term investment as of March 31, 2009. See note 13 for more information.

 

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Plant and equipment—net:

 

     March 31,
2009
    December 31,
2008
 

Cost:

    

Land

   $ 30     $ 31  

Buildings

     963       991  

Machinery and equipment

     1,725       1,761  

Assets under capital lease

     186       193  

Sale lease-back assets

     72       90  
                
     2,976       3,066  
                

Less: accumulated depreciation:

    

Buildings

     (363 )     (369 )

Machinery and equipment

     (1,326 )     (1,307 )

Assets under capital lease

     (97 )     (98 )

Sale lease-back assets

     (18 )     (20 )
                
     (1,804 )     (1,794 )
                

Plant and equipment—net (a)

   $ 1,172     $ 1,272  
                

 

(a) Includes assets held for sale with a carrying value of $51 as of March 31, 2009 and December 31, 2008, related to owned facilities that were being actively marketed for sale. See note 21.

Intangible assets—net:

 

     March 31,
2009
    December 31,
2008
 

Cost

   $ 284     $ 294  

Less: accumulated amortization

     (155 )     (151 )
                

Intangible assets—net

   $ 129     $ 143  
                

Other assets:

 

     March 31,
2009
   December 31,
2008

Long-term deferred costs

   $ 117    $ 146

Long-term inventories

     14      22

Debt issuance costs

     58      61

Derivative assets

     5      126

Financial assets

     38      41

Other

     71      79
             

Other assets

   $ 303    $ 475
             

 

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Other accrued liabilities:

 

    March 31,
2009
  December 31,
2008

Outsourcing and selling, general and administrative related provisions

  $ 182   $ 246

Customer deposits

    9     10

Product-related provisions

    82     225

Warranty provisions (note 12)

    175     186

Deferred revenue

    941     972

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

    692     751

Miscellaneous taxes

    7     29

Income taxes payable

    33     65

Deferred income taxes

    7     13

Tax uncertainties (note 10)

    13     15

Interest payable

    —       112

Other

    49     50
           

Other accrued liabilities

  $ 2,190   $ 2,674
           

 

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

Other liabilities:

 

     March 31,
2009
   December 31,
2008

Pension benefit liabilities

   $ 34    $ 1,557

Post-employment and post-retirement benefit liabilities

     189      670

Restructuring liabilities (note 8)

     113      161

Deferred revenue

     219      271

Tax uncertainties

     87      92

Derivative liabilities

     —        62

Other long-term provisions

     90      135
             

Other liabilities

   $ 732    $ 2,948
             

Condensed combined and consolidated statements of cash flows

Change in operating assets and liabilities—net:

 

     Three Months Ended March 31,  
         2009             2008      

Accounts receivable—net

   $ 462     $ 245  

Inventories—net

     9       (25 )

Deferred costs

     76       210  

Income taxes

     (5 )     (6 )

Accounts payable

     52       (121 )

Payroll, accrued and contractual liabilities

     (87 )     (264 )

Deferred revenue

     (69 )     (16 )

Advance billings in excess of revenues recognized to date on contracts

     (59 )     (250 )

Restructuring liabilities

     (25 )     (51 )

Other

     (7 )     (51 )
                

Change in operating assets and liabilities—net

   $ 347     $ (329 )
                

 

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Interest, taxes and net reorganization items paid:

 

     Three Months Ended
March 31,
     2009    2008

Cash interest paid

   $ 7    $ 111

Cash taxes paid

   $ 8    $ 30

Net payment for reorganization items (note 4)

   $ 10    $ —  

6. Goodwill

The following table outlines goodwill by reportable segment:

 

     LGN (a)     Other     Total  

Balance—as of December 31, 2008

   $ 9     $ 171     $ 180  

Change:

      

Additions

     —         —         —    

Disposals

     —         —         —    

Foreign exchange

     —         —         —    

Other

     (1 )     —         (1 )

Impairment

     —         (48 )     (48 )
                        

Balance—as of March 31, 2009

   $ 8     $ 123     $ 131  
                        

 

(a) Amount was previously included in the CN business unit. See note 7.

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. Nortel determines the fair value of its reporting units using an income approach; specifically, based on a Discounted Cash Flow (“DCF”) Model. A market approach may also be used to evaluate the reasonableness of the fair value determined under the DCF Model, but results of the market approach are not given any specific weighting in the

 

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final determination of fair value. Both approaches involve significant management judgment and as a result, estimates of value determined under the approaches are subject to change in relation to evolving market conditions and Nortel’s business environment.

If the carrying amount of a reporting unit exceeds its fair value, step two of the goodwill impairment test 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 the determination of 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).

The fair value of each reporting unit is determined using discounted cash flows. When circumstances warrant, 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”). The following are the significant assumptions involved in the application of each valuation approach:

 

   

DCF Model: assumptions regarding revenue growth rates, gross margin percentages, projected working capital needs, SG&A expense, R&D expense, capital expenditures, discount rates, terminal growth rates, and estimated selling price of assets expected to be disposed of by sale. To determine fair value, Nortel discounts the expected cash flows of each reporting unit. The discount rate used 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. When strategic plans call for the sale of all or an important part of a reporting unit, Nortel estimates proceeds from the expected sale using external information, such as third party bids, adjusted to reflect current circumstances, including market conditions.

 

   

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

Interim Goodwill Assessment

At March 31, 2009, in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), Nortel concluded that events had occurred and circumstances had changed that required it to perform an interim period goodwill impairment test for the reporting unit in its Other segment, Nortel Government Solutions (“NGS”). Given the nature of the business operations and the decline in the economic outlook, management decided to place significant weighting on the results of the DCF model in establishing the fair value of this reporting unit. The decision was based on a lack of direct comparable companies. The results from step one of the two-step goodwill impairment test indicated that the estimated fair value of NGS was less than the carrying value of its net assets and as such Nortel performed step two of the impairment test for this reporting unit.

In step two of the impairment test, Nortel was required to measure the potential impairment loss by allocating the estimated fair value of the reporting unit, as determined in step one, to the reporting unit’s recognized and unrecognized assets and liabilities, with the residual amount representing the implied fair value of goodwill and, to the extent the implied fair value of goodwill was less than the carrying value, an impairment loss was recognized. As such, the step two test required Nortel to perform a theoretical purchase price allocation for NGS to determine the implied fair value of goodwill as of the evaluation date. In accordance with the guidance in SFAS 142, Nortel completed a preliminary assessment of the expected impact of the step two tests using reasonable estimates for the theoretical purchase price allocation and recorded a preliminary goodwill

 

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impairment charge of approximately $48 that will be subject to adjustment when the step two test is finalized in the quarter ending June 30, 2009.

No goodwill impairment losses were recorded during the three months ended March 31, 2008.

Related Analyses

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 relevant long-lived assets assigned to specific asset groupings, where appropriate. The undiscounted future cash flows, inclusive of estimated proceeds on disposition of the long-lived assets exceeded their net book value and, as a result, no impairment charge was recorded.

7. Segment information

Segment descriptions

As of March 31, 2009, Nortel’s four reportable segments were: CN, ES, MEN, and LGN:

 

   

The CN segment provides wireline and wireless networks and related services that help service providers and cable operators supply mobile voice, data and multimedia communications services for individuals and enterprises using cellular telephones, personal digital assistants, laptops, soft-clients, and other wireless computing and communications devices. CN also offers circuit- and packet-based voice switching products that provide local, toll, long distance and international gateway capabilities for local and long distance telephone companies, wireless service providers, cable operators and other service providers.

 

   

The ES segment provides large and small businesses with reliable, secure and scalable communications solutions including unified communications, Ethernet routing and multiservice switching, IP and digital telephony (including phones), wireless LANs (local area networks), security, IP (internet protocol) and SIP (session initiation protocol) contact centers, self-service solutions, messaging, conferencing and SIP-based multimedia solutions, and related services.

 

   

The MEN segment solutions are designed to deliver carrier-grade Ethernet transport capabilities focused on meeting customer needs for higher performance and lower cost, with a portfolio that includes optical networking, Carrier Ethernet switching, and multiservice switching products and related services.

 

   

The LGN segment provides telecommunications equipment and network solutions, spanning wired and wireless technologies, to both service providers as well as enterprise customers in both the domestic Korean market and internationally . LGN’s Carrier Network business unit offers advanced CDMA and UMTS solutions to wireless service providers and also includes the Ethernet Fiber Access product line based on next-generation WDM-PON technology. LGN’s Enterprise Solutions business unit offers a broad and diverse portfolio of voice, data, multimedia, unified communication systems and devices for business communication solutions.

Effective January 1, 2009, Nortel decentralized several corporate functions and transitioned to a vertically integrated business unit structure. Enterprise customers are served by a business unit responsible for product and portfolio development, research and development expense (“R&D”), marketing and sales, partner and channel management, strategic business development and associated functions. Service provider customers are served by two business units with full responsibility for all product, services, applications, portfolio, business and market development, marketing and R&D functions: CN and MEN.

Nortel’s Global Services business unit, formerly a reportable business segment, has been decentralized and transitioned to the other reportable segments as of the first quarter of 2009. In addition, commencing with the

 

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first quarter of 2009, Nortel began reporting LGN as a separate reportable segment. Prior to that time, the results of LGN were reported across all Nortel’s reportable segments. Also commencing with the first quarter of 2009, services results are reported across all reportable segments (CN, ES, MEN and LGN). Comparative periods have been recast to conform to the current segment presentation.

Other miscellaneous business activities and corporate functions, including the operating results of NGS, 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 (“CEO”) has been identified as the Chief Operating Decision Maker in assessing the performance of and allocating resources to Nortel’s operating segments. The primary financial measure used by the CEO is Management Operating Margin (“Management OM”) (previously called Operating Margin (“OM”) in Nortel’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008). Management OM, presented on a combined or consolidated basis, is not a recognized measure under U.S. GAAP. It is a measure defined as total revenues, less total cost of revenues, SG&A and R&D expense. The accounting policies of the reportable segments are the same as those applied to the combined and consolidated financial statements. The CEO does not review asset information on a segmented basis in order to assess performance and allocate resources.

 

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Segments

The following tables set forth information by segment for the three months ended:

 

     March 31,
2009
    March 31,
2008
 

Revenues

    

Carrier Networks

   $ 737     $ 1,089  

Enterprise Solutions

     395       668  

Metro Ethernet Networks

     360       402  

LG-Nortel

     188       546  
                

Total reportable segments

     1,680       2,705  

Other

     53       53  
                

Total revenues

   $ 1,733     $ 2,758  
                

Management OM

    

Carrier Networks

   $ 42     $ 143  

Enterprise Solutions

     (128 )     (83 )

Metro Ethernet Networks

     42       2  

LG-Nortel

     48       174  
                

Total reportable segments

     4       236  

Other

     (248 )     (107 )
                

Total Management OM (a)

     (244 )     129  
                

Amortization of intangible assets

     10       12  

Special charges

     —         88  

Gain on sales of businesses and assets

     (15 )     (2 )

Goodwill impairment

     48       —    

Other operating expense (income)—net

     (12 )     13  
                

Operating earnings (loss)

     (275 )     18  

Other expense—net

     (70 )     (1 )

Interest and dividend income

     —         38  

Interest expense

     (77 )     (80 )

Income tax expense

     (7 )     (36 )

Noncontrolling interests—net of tax

     (26 )     (78 )

Equity in net earnings of associated companies—net of tax

     —         1  

Reorganization items—net

     (52 )     —    
                

Net loss attributable to NNC

   $ (507 )   $ (138 )
                

 

(a) As disclosed in note 9 and 17, cost reduction activities and costs related to the termination of certain equity-based compensation plans, aggregating $174, are included in Management OM for the period ended March 31, 2009.

Nortel had one customer, Verizon Communications Inc., that generated revenues of approximately 12% of total combined and consolidated revenues for the three months ended March 31, 2009 and 2008. Although, these revenues were generated primarily within the CN segment, they were also from the ES and MEN segments.

8. Pre-Petition Date cost reduction plans

As a result of the Creditor Protection Proceedings, Nortel ceased taking any further actions under the previously announced workforce and cost reduction plans as of January 14, 2009. Any revisions to actions taken up to that date under previously announced workforce and cost reduction plans will continue to be accounted for

 

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under such plans, and be classified in cost of revenues, selling, general and administrative expense (“SG&A”), and R&D as applicable. Any remaining actions under these plans will be accounted for under the workforce reduction plan announced on February 25, 2009 (see note 9). Nortel’s contractual obligations are subject to re-evaluation in connection with the Creditor Protection Proceedings and, as a result, expected cash outlays disclosed below relating to contract settlement and lease costs are subject to change. As well, Nortel is not following its pre-Petition Date practices with respect to the payment of severance in jurisdictions under the Creditor Protection Proceedings.

On November 10, 2008, Nortel announced a restructuring plan that included net workforce reductions of approximately 1,300 positions and shifting approximately 200 additional positions from higher-cost to lower-cost locations (collectively “2009 Restructuring Plan”). Nortel expected total charges to earnings and cash outlays related to those workforce reductions to be approximately $130. Approximately $58 of the total charges relating to the net reduction of 550 positions under the November 2008 Restructuring Plan were incurred as of December 31, 2008. There were no significant workforce reductions under this plan after December 31, 2008 and prior to its discontinuance on January 14, 2009.

During the first quarter of 2008, 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. 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, “2008 Restructuring Plan”). Nortel expected total charges to earnings and cash outlays related to workforce reductions to be approximately $205 and expected total charges to earnings related to the consolidation of real estate to be approximately $60, including approximately $15 related to fixed asset write-downs. Approximately $148 of the total charges relating to the net reduction of approximately 1,500 positions and real estate reduction initiatives under the 2008 Restructuring Plan were incurred during the year ended December 31, 2008. There were no significant workforce reductions under this plan after December 31, 2008 and prior to its discontinuance on January 14, 2009. The real estate provision of $13 as at March 31, 2009 relates to discounted cash outlays, net of estimated future sublease revenues, for leases with payment terms through to 2024.

During the first quarter of 2007, Nortel announced a restructuring plan that included workforce reductions of approximately 2,900 positions and shifting approximately 1,000 additional positions from higher-cost locations to lower-cost locations. 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, “2007 Restructuring Plan”). Nortel originally expected charges to earnings and cash outlays for the 2007 Restructuring Plan to be approximately $390 and $370, respectively. Approximately $243 of the total charges relating to the net reduction of approximately 2,150 positions and real estate reduction initiatives under the 2007 Restructuring Plan have been incurred as of December 31, 2008. There were no significant workforce reductions under this plan after December 31, 2008 and prior to its discontinuance on January 14, 2009. The real estate provision of $13 as at March 31, 2009 relates to discounted cash outlays net of estimated future sublease revenues related to leases with payment terms through to 2016.

During 2006, 2004 and 2001, Nortel implemented work plans to streamline operations through workforce reductions and real estate optimization strategies (“2006 Restructuring Plan”, “2004 Restructuring Plan” and “2001 Restructuring Plan”). All of the charges with respect to these workforce reductions have been incurred. The real estate provision of $131 in the aggregate as at March 31, 2009 relates to discounted cash outlays net of estimated future sublease revenues, for leases with payment terms through to 2016 for the 2004 Restructuring Plan and the end of 2013 for the 2001 Restructuring Plan.

 

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During the three months ended March 31, 2009 changes to the provision balances were as follows:

 

                            Charge (recovery)  
    Workforce
reduction
    Contract
settlement and
lease costs
    Plant and
equipment
write downs
    Total     Three Months
Ended

March 31, 2009
 

November 2008 Restructuring Plan

         

Provision balance as of December 31, 2008

  $ 53     $ —       $ —       $ 53     $ —    

Current period charges

    1       —         —         1       1  

Revisions to prior accruals

    (15 )     —         —         (15 )     (15 )

Cash drawdowns

    (4 )     —         —         (4 )  

Non-cash drawdowns

    —         —         —         —      

Foreign exchange and other adjustments

    (1 )     —         —         (1 )  
                                       

Provision balance as of March 31, 2009

  $ 34     $ —       $ —       $ 34     $ (14 )
                                       

2008 Restructuring Plan

         

Provision balance as of December 31, 2008

  $ 46     $ 7     $ —       $ 53    

Current period charges

    1       3       2       6       6  

Revisions to prior accruals

    (9 )     (1 )     —         (10 )     (10 )

Lease repudiation

    —         3       —         3       3  

Cash drawdowns

    (10 )     —         —         (10 )  

Non-cash drawdowns

    —         —         (2 )     (2 )  

Foreign exchange and other adjustments

    (1 )     1       —         —      
                                       

Provision balance as of March 31, 2009

  $ 27     $ 13     $ —       $ 40     $ (1 )
                                       

2007 Restructuring Plan

         

Provision balance as of December 31, 2008

  $ 18     $ 27     $ —       $ 45    

Current period charges

    —         (1 )     —         (1 )     (1 )

Revisions to prior accruals

    (2 )     (1 )     —         (3 )     (3 )

Lease repudiation

    —         (12 )     —         (12 )     (12 )

Cash drawdowns

    (5 )     (1 )     —         (6 )  

Non-cash drawdowns

    —         —         —         —      

Foreign exchange and other adjustments

    —         1       —         1    
                                       

Provision balance as of March 31, 2009

  $ 11     $ 13     $ —       $ 24     $ (16 )
                                       

2004 and 2001 Restructuring Plan

         

Provision balance as of December 31, 2008

  $ —       $ 156     $ —       $ 156    

Current period charges

    —         1       —         1       1  

Revisions to prior accruals

    —         (5 )     —         (5 )     (5 )

Lease repudiation

    —         (19 )     —         (19 )     (19 )

Cash drawdowns

    —         (2 )     —         (2 )  

Non-cash drawdowns

    —         —         —         —      

Foreign exchange and other adjustments

    —         —         —         —      
                                       

Provision balance as of March 31, 2009

  $ —       $ 131     $ —       $ 131     $ (23 )
                                       

Total provision balance as of March 31, 2009 (a)

  $ 72     $ 157     $ —       $ 229    
                                 

Total charges (recovery)

          $ (54 )
               

 

(a) As of March 31, 2009 and December 31, 2008, the short-term provision balances were $13 and $146, respectively, and the long-term provision balances were $112 and $161, respectively, and $104 was included in liabilities subject to compromise at March 31, 2009.

 

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During the three months ended March 31, 2009 charges (recovery) by profit and loss category were as follows:

 

     Total  

Cost of revenues

   $ (8 )

Selling, general and administrative

     (15 )

Research and development

     (4 )

Reorganization items—lease repudiation

     (28 )

Other

     1  
        

Total charges (recovery)

   $ (54 )
        

The following table sets forth charges (recovery) incurred for each of Nortel’s cost reduction plans by segment during the three months ended March 31, 2009 and 2008:

 

    Enterprise
Solutions
    Carrier
Networks
    Metro
Ethernet
Networks
    LGN   Other   Total  

November 2008 Restructuring Plan

  $ (4 )   $ (8 )   $ (2 )   $ —     $ —     $ (14 )

2008 Restructuring Plan

    —         (1 )     —         —       —       (1 )

2007 Restructuring Plan

    (2 )     (12 )     (2 )     —       —       (16 )

2004 Restructuring Plan

    —         (1 )     —         —       —       (1 )

2001 Restructuring Plan

    (7 )     (11 )     (4 )     —       —       (22 )
                                           

Total recovery for the three months ended March 31, 2009

  $ (13 )   $ (33 )   $ (8 )   $ —     $ —     $ (54 )
                                           

2008 Restructuring Plan

    30       25       12       —       —       67  

2007 Restructuring Plan

    4       12       8       —       —       24  

2004 Restructuring Plan

    —         —         —         —       —       —    

2001 Restructuring Plan

    (1 )     (1 )     (1 )     —       —       (3 )
                                           

Total charges for the three months ended March 31, 2008

  $ 33     $ 36     $ 19     $ —     $ —     $ 88  
                                           

A significant portion of Nortel’s provisions for workforce reductions and contract settlement and lease costs is 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. Previously, Nortel allocated these costs only based on headcount and revenue streams. Charges related to these plans in 2008 were recorded in special charges and were not included in the calculation of Management OM, while any revisions to provisions after this date will be recorded in operations and are included in the calculation of Management OM.

9. Post-Petition Date cost reduction activities

In connection with the Creditor Protection Proceedings, Nortel has commenced certain workforce and other cost reduction activities and will undertake further workforce and cost reduction activities during this process. The actions related to these activities are expected to occur as they are identified. The following current estimated charges are based upon accruals made in accordance with U.S. GAAP. The current estimated total charges and cash outlays are subject to change as a result of Nortel’s ongoing review of applicable law. In addition, the current estimated total charges to earnings and cash outlays do not reflect all potential claims or contingency amounts that may be allowed under the Creditor Protection Proceedings and thus are also subject to change.

Workforce Reduction Activities

On February 25, 2009, Nortel announced a workforce reduction plan that, upon completion, is currently expected to result in annual gross savings of approximately $560, with total charges to earnings of approximately

 

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$270 and total cash outlays upon terminations of approximately $160. The charges and cash outlays are expected to be incurred in 2009. Approximately $74 of the total charges relating to the net workforce reduction of 2,950 positions have been incurred as of March 31, 2009.

Three months ended March 31, 2009

For the three months ended March 31, 2009, Nortel recorded charges of $74 associated with a workforce reduction of approximately 2,950 employees, of which approximately 1,675 were notified of termination during the three months ended March 31, 2009. 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.

During the three months ended March 31, 2009 changes to the provision balances were as follows:

 

     Workforce
reduction
 

Provision balance as of December 31, 2008

   $ —    

Other charges

     74  

Revisions to prior accruals

     —    

Cash drawdowns

     (2 )

Non-cash drawdowns

     (3 )

Foreign exchange and other adjustments

     —    
        

Provision balance as of March 31, 2009

   $ 69  
        

During the three months ended March 31, 2009 workforce reduction charges were as follows:

 

     Total

Cost of revenues

   $ 27

SG&A

     26

R&D

     21
      

Total workforce reduction charges

   $ 74
      

The following table sets forth charges incurred by segment during the three months ended March 31, 2009:

 

     Total

Enterprise Solutions

   $ 37

Carrier Networks

     27

Metro Ethernet Networks

     10
      

Total charges

   $ 74
      

Other Cost Reduction Activities

During the three months ended March 31, 2009, the real estate initiative resulted in costs of $6, which were recorded as an SG&A expense and recorded a charge in R&D expense of $2 related to plant and equipment write downs.

10. Income taxes

During the three months ended March 31, 2009, Nortel recorded a tax expense of $7 on loss from operations before income taxes and equity in net earnings of associated companies of $474. The tax expense of $7 was

 

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largely comprised of $16 of income taxes in profitable jurisdictions primarily in Asia, which was offset by decreases in uncertain tax positions of $2 and a benefit of $7 from various tax credits and R&D related incentives.

During the three months ended March 31, 2008, Nortel recorded a tax expense of $36 on loss from operations before income taxes and equity in net earnings of associated companies of $25. The tax expense of $36 was largely comprised of several significant items including $62 of income taxes on profitable entities in Asia and Europe, including a reduction of Nortel’s deferred tax assets in EMEA and other taxes of $4 primarily related to taxes on preferred share dividends in Canada. This tax expense was partially offset by a $13 benefit derived from various tax credits and R&D related incentives, a $15 benefit resulting from decreases in uncertain tax positions and a $2 benefit resulting from revisions to prior year tax estimates and refunds.

As of March 31, 2009, Nortel’s net deferred tax assets were $23. During the third and fourth quarters of 2008, the expanding global economic downturn dramatically worsened, and in January 2009, the Debtors commenced the Creditor Protection Proceedings. In assessing the need for valuation allowances against its deferred tax assets for the year ended December 31, 2008, Nortel considered the negative effect of these events on Nortel’s revised modeled forecasts and the resulting increased uncertainty inherent in these forecasts. Nortel determined that there was significant negative evidence against and insufficient positive evidence to support a conclusion that Nortel’s net deferred tax assets were more likely than not to be realized in future tax years in all tax jurisdictions other than Korea and Turkey. These factors continue to support our conclusion that as at March 31, 2009 a full valuation allowance continues to be necessary in all jurisdictions other than Korea and Turkey. Therefore, a full valuation allowance was necessary against Nortel’s net deferred tax asset in all tax jurisdictions other than in Korea and Turkey. Nortel’s net deferred tax asset was reduced from $32 as of December 31, 2008 to $23 as at March 31, 2009 primarily as a result of the effects of foreign exchange translation and changes in deferred tax assets arising from profitable jurisdictions resulting from operations in the ordinary course of business.

In Canada, the Federal and Ontario governments signed a Memorandum of Agreement that provides for the federal administration of Ontario corporate income tax by the Canada Revenue Agency. To achieve this Ontario harmonization, Ontario will adopt the Federal definition of taxable income and Federal tax attributes will replace Ontario tax attributes resulting in a transitional debit or credit. As a result of the harmonization, there are no transitional taxes payable. The Company reduced its Ontario tax attributes and recorded a transitional credit of approximately $189 which is fully offset by a valuation allowance. The transitional tax credit can be applied to reduce Ontario taxes payable over a five year period commencing with the first tax year ending in 2009.

Nortel had approximately $1,631 and $1,669 of total gross unrecognized tax benefits as of December 31, 2008 and March 31, 2009 respectively. As of March 31, 2009, of the total gross unrecognized tax benefits, $56 represented the amount of unrecognized tax benefits that would favorably affect the effective income tax rate in future periods, if recognized. The net increase of $38 since December 31, 2008 resulted from an increase of $11 for new uncertain tax positions arising in 2009, an increase of $56 arising from uncertain tax positions taken during prior periods, offset by a decrease of $29 resulting from changes to the measurement of existing uncertain tax positions for changes to foreign exchange rates and other measurement criteria.

Nortel recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. Nortel had approximately $46 accrued for the payment of interest and penalties as of December 31, 2008 and March 31, 2009.

Nortel believes it is reasonably possible that $623 of its gross unrecognized tax benefit will decrease during the twelve months ending March 31, 2010 with such amount attributable to possible decreases of $548 in the aggregate from the potential resolution of Nortel’s ongoing Advance Pricing Arrangements (“APA”) negotiations, $54 from including unrecognized tax benefits on amended income tax returns, and $21 from the

 

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potential settlement of audit exposures. If achieved, it is anticipated that $10 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 2008 tax years remain open in most of these jurisdictions primarily as a result of the ongoing APA negotiations.

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 $65 for the 1999 and 2000 taxation years. In addition, the tax authorities in France issued assessments in respect of the 2001, 2002 and 2003 taxation years. These France assessments collectively propose adjustments to increase taxable income by approximately $1,115, additional income tax liabilities of $44 inclusive of interest, as well as certain increases to withholding and other taxes of approximately $89 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 with the competent authority under the Canada-France tax treaty to settle the dispute and to avoid double taxation. Nortel believes that it has adequately provided for the tax adjustments that are more likely than not to be realized as a result of these ongoing examinations.

Nortel had previously entered into APAs with the U.S. and Canadian taxation authorities in connection with its intercompany 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 2001 through 2005 taxation years (“2001-2005 APA”). The 2001-2005 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 paper regarding the 2001-2005 APA under negotiation. The supplemental position paper suggests a material reallocation of losses from the U.S. to Canada. Nortel received verbal communication from the U.S. taxing authority in December 2008 stating that a tentative agreement on the 2001-2005 APA had been reached between the U.S. and Canadian taxing authorities. Nortel has not received any communication from the taxing authorities regarding the details of this tentative agreement. Nortel expects the Canadian and U.S. tax authorities to meet to discuss the details of the agreement in the next few quarters. 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 2001-2005 APA 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 its accounts for its 2001 to 2005 taxation years. These parties are the U.S., Canada, the U.K., France, Ireland and Australia.

During 2007 and 2008, Nortel requested new bilateral APAs for tax years 2007 through at least 2010 (“2007-2010 APA”), for Canada, the U.S. and France, 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. The ultimate outcome of the 2007—2010 APA negotiations is uncertain and the ultimate reallocation of losses as they relate to the 2007—2010 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. It is also uncertain whether the Creditor Protection Proceedings will have any impact on the ultimate resolution of the APA negotiations. If these matters are resolved unfavorably, they could have a material adverse effect on Nortel’s consolidated financial position, results of operations and/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 and/or cash flows.

 

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11. 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: 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.

On January 14, 2009, as a result of the U.K. Proceedings, the U.K. defined benefit pension plan entered the Pension Protection Fund (“PPF”) assessment process and all further service cost accruals and contributions ceased. Employees who were currently enrolled in the U.K. defined benefit pension plan were given the option of participating in the U.K. defined contribution scheme. As a result of these changes Nortel remeasured the pension obligations related to the U.K. defined benefit pension plan on January 14, 2009, and recorded the impacts of this remeasurement in the first quarter of 2009 in accordance with SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits”. The ceasing of service cost accruals resulted in a curtailment gain of approximately $22. As a result of this remeasurement, Nortel changed its U.K. discount rate, a key assumption used in estimating pension costs. However, this did not result in a change to our weighted average discount rate of 6.4% for all the pension plans from that at December 31, 2008. In addition as a result of the remeasurement, Nortel was required to adjust the liability for impacts from the curtailment gain, changes in assumptions, and asset losses at the re-measurement date. The effect of this adjustment and the related foreign currency translation adjustment was to increase pension liabilities and accumulated other comprehensive loss (before tax) by $107. As discussed in note 2, contributions to the U.K. defined benefit pension plan have been guaranteed by NNL.

The Pension Protection Fund assessment process can take up to two years, or longer, and will result in the PPF deciding whether it needs to take on the U.K. defined benefit pension plans or whether there are sufficient assets to secure equivalent or greater than PPF benefits through a “buy out” with an insurance company. If the PPF decides it needs to take on the U.K. defined benefit pension plan, the expected claim amount will be significantly more than the carrying amount of the liability.

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 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

 

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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
March 31,
 
         2009             2008      

Pension expense:

    

Service cost

   $ 6     $ 13  

Interest cost

     103       128  

Expected return on plan assets

     (93 )     (135 )

Amortization of prior service cost

     1       1  

Amortization of net losses

     18       10  

Curtailment, contractual and special termination losses

     4       2  
                

Net pension expense

   $ 39     $ 19  
                

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

 

     Three months ended
March 31,
 
         2009             2008      

Post-retirement benefit cost:

    

Service cost

   $ 1     $ 1  

Interest cost

     8       10  

Amortization of prior service cost

     (2 )     (2 )

Amortization of net losses (gains)

     (3 )     —    
                

Net post-retirement benefit cost

   $ 4     $ 9  
                

During the three months ended March 31, 2009 and 2008, contributions of $43 and $110, respectively, were made to the defined benefit plans and $11 and $11, respectively, to the post-retirement benefit plans. Nortel expects to contribute an additional $32 in 2009 to the defined benefit pension plans for a total contribution of $75, and an additional $33 in 2009 to the post-retirement benefit plans for a total contribution of $44.

12. Guarantees

Nortel’s requirement to make payments (either in cash, financial instruments, other assets, NNC common shares or through the provision of services) to a third party will be triggered as a result of changes in an underlying economic characteristic (such as interest rates or market value) that is related to an asset, a liability or an equity security of the guaranteed party or a third party’s failure to perform under a specified agreement.

 

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The following table provides a summary of Nortel’s guarantees as of March 31, 2009:

 

     Carrying
Amount of
Liability
   Maximum
Potential
Liability (l)

Business sale and business combination agreements

     

Third party claims (a)

   $ 9    $ 13

Sales volume guarantee (b)

     —        —  

Intellectual property indemnification obligations (c)

     —        —  

Lease agreements (d)

     —        14

Receivable securitizations (e)

     —        12

Other indemnification agreements

     

EDC Support Facility (f)

     —        —  

Specified price trade-in rights (g)

     —        —  

Global Class Action Settlement (h)

     —        —  

Sale lease-back (i)

     —        4

Real estate indemnification (j)

     —        —  

Bankruptcy (k)

     —        1
             

Total

   $ 9    $ 44
             

 

(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 as part of 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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected payout, if required.
(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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.
(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 obligations 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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.
(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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.

 

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(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 extended through 2009, or collection of the receivable amounts by the purchaser. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(f) Nortel has also agreed to indemnify EDC under the EDC Support Facility against any legal action brought against EDC that relates to the provision of support under the EDC Support Facility. As described further in note 2, NNL’s continued access to the EDC Support Facility has been limited. As of March 31, 2009, there was approximately $152 of outstanding support utilized under the EDC Support Facility. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.
(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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(h) On March 17, 2006, in connection with the Global Class Action Settlement (as defined in note 22 of the 2008 Annual Report), 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. As of March 31, 2009, Nortel has not made any significant payments to settle such obligations and does not expect to do so in the future.
(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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(j) On February 14, 2008, NNI entered into an agreement whereby it indemnified the landlord of a property against certain obligations 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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future.
(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. As of March 31, 2009, Nortel has not made any payments to settle such obligations and does not expect to do so in the future. However, an immaterial amount has been accrued for this liability, based on the probability of payout and expected pay-out, if required.
(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.

 

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Product warranties

The following summarizes the accrual for product warranties that was recorded as part of other accrued liabilities in the condensed combined and consolidated balance sheet as of March 31, 2009:

 

Balance as of December 31, 2008

   $  186  

Payments

     (40 )

Warranties issued

     46  

Revisions

     (17 )
        

Balance as of March 31, 2009

   $ 175  
        

13. Fair Value

Nortel adopted the provisions of SFAS 157 applicable to financial assets and liabilities measured at fair value on a recurring basis 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.

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 security, exercise price, shares issuable, risk free rate, forecasted dividends and volatility. Such items are classified in Level 2 of the fair value hierarchy.

 

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Nortel has an investment in the Fund, which, prior to the suspension of trading activities of the fund’s shares, was classified as cash and cash equivalents. The portion of this investment which has not been distributed back to Nortel is currently classified in Level 3 of the fair value hierarchy. See note 5 for more information.

In October 2008, Nortel entered into an agreement (“Agreement”) with the investment firm that sold Nortel a portion of its auction rate securities, which have a par value of $18 at March 31, 2009. By entering into the Agreement, Nortel (1) received the right (“Put Option”) to sell these auction rate securities back to the investment firm at par, at its sole discretion, anytime during the period from June 30, 2010 through July 2, 2012, and (2) gave the investment firm the right to purchase these auction rate securities or sell them on Nortel’s behalf at par anytime after the execution of the Agreement through July 2, 2012. Nortel elected to measure the Put Option under the fair value option of SFAS 159, and recorded pre-tax income of approximately $3 in 2008, and a corresponding long term investment. Simultaneously, Nortel transferred these auction rate securities from available-for-sale to trading investment securities. As a result of this transfer, Nortel recognized pre-tax impairment loss of approximately $3 in 2008. Nortel anticipates that any future changes in the fair value of the Put Option will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the results of operations. The Put Option will continue to be measured at fair value utilizing Level 3 inputs until the earlier of its maturity or exercise. The value has not changed significantly as of March 31, 2009.

Derivatives

All outstanding derivatives at December 31, 2008 were terminated in the quarter ended March 31, 2009 and Nortel has no outstanding derivatives at March 31, 2009. In connection with the terminations, Nortel recognized loss of $5 on interest rate swaps and a loss of $5 on foreign exchange 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 must include 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 14 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 March 31, 2009:

 

     Fair Value    Level 1    Level 2    Level 3

Assets

           

Derivatives

   $ 5    $ —      $ —      $ 5

Reserve Primary Fund

     41      —        —        41

Employee benefit trust

     65      65      —        —  

Auction rate securities (including Put Option)

     18      —        —        18
                           

Total Assets

   $ 129    $ 65    $ —      $ 64
                           

Liabilities

           

Long-term debt

   $ 690    $ 690    $ —      $ —  
                           

Total Liabilities

   $ 690    $ 690    $ —      $ —  
                           

 

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The following table presents the changes in the Level 3 fair value category for the three months ended March 31, 2009:

 

    January 1,
2009
  Net Realized/Unrealized Gains
(Losses) included in
  Purchases,
Sales, Issuances
and

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

Level 3
  March 31,
2009
    Earnings     Other      

Assets

           

Derivatives

  $ 20   $ (15 )   $ —     $ —     $ —     $ 5

Reserve Primary Fund

  $ —     $ —       $ —     $ —     $ 41   $ 41

Auction rate securities (including Put Options)

  $ 19     (1 )     —       —       —     $ 18

14. 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 made material payments under these types of bonds and as a result of the Creditor Protection Proceedings and does not anticipate that it will be required to make such payments during the pendency of the Creditor Protection Proceedings.

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:

 

     March 31,
2009
   December 31,
2008

Bid and performance-related bonds (a)

   $ 141    $ 167

Other bonds (b)

     54      57
             

Total bid, performance-related and other bonds

   $ 195    $ 224
             

 

(a) Net of restricted cash and cash equivalent amounts of $7 and $4 as of March 31, 2009 and December 31, 2008, respectively.
(b) Net of restricted cash and cash equivalent amounts of $21 and $7 as of March 31, 2009 and December 31, 2008, 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 $15 as of March 31, 2009. These commitments expire at various dates through to 2017.

Concentrations of risk

Nortel has from time to time, used derivatives to limit exposures related to foreign currency, interest rate and equity price risk. Nortel does not enter into derivatives for trading or speculative purposes. As at

 

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December 31, 2008, Nortel had entered into forward contracts to manage certain foreign exchange cash flows, which contracts were not designated as hedges in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging (“SFAS 133”), and interest rate swaps to manage our debt instruments fair value risk, which were designated and accounted for as fair value hedges under SFAS 133. During the quarter ended March 31, 2009 all derivatives were terminated.

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 short-term money market instruments, the balances of which, at times, may exceed the amount of insurance provided on such deposits. Generally, these deposits 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 require collateral from its customers. Nortel’s customers are primarily in the 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.

15. 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 March 31,  
         2009 (a)             2008 (a)       
     (in millions, except per share amounts)  

Net loss attributable to Nortel

   $ (507 )   $ (138 )
                

Basic weighted-average shares outstanding:

    

Issued and outstanding

     499       498  
                

Weighted-average shares dilution adjustments—exclusions:

    

Stock options and share-based awards

     24       41  

4.25% Convertible Senior Notes

     —         7  

1.75% Convertible Senior Notes

     18       18  

2.125% Convertible Senior Notes

     18       18  

Basic and diluted loss per common share

   $ (1.02 )   $ (0.28 )
                

 

(a) As a result of net loss for the three months ended March 31, 2009 and 2008, all potential dilutive securities in this period were considered anti-dilutive.

 

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16. Shareholders’ deficit

The following are the changes in shareholders’ deficit during the three months ended March 31, 2009:

 

    NNC
Common
Shares
  Additional
Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Noncontrolling
Interests
    Total  

Balance as of December 31, 2008

  $ 35,593   $ 3,547     $ (42,362 )   $ (729 )   $ 822     $ (3,129 )

Net income (loss)

    —       —         (507 )     —         26       (481 )

Foreign currency translation adjustment

    —       —         —         (9 )     (18 )     (27 )

Unrealized loss on investments—net

    —       —         —         (2 )     —         (2 )

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

    —       —         —         (89 )     —         (89 )

Share-based compensation

    —       101       —         —         —         101  

Other

    3     (3 )     (3 )     —         (5 )     (8 )
                                             

Balance as of March 31, 2009

  $ 35,596   $ 3,645     $ (42,872 )   $ (829 )   $ 825     $ (3,635 )
                                             

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

The following are the components of comprehensive loss for the three months ended:

 

     March 31,
2009
    March 31,
2008
 

Net loss including noncontrolling interests

   $ (481 )   $ (60 )

Other comprehensive loss adjustments:

    

Change in foreign currency translation adjustment

     (27 )     (7 )

Unrealized loss on investments—net (a)

     (2 )     (8 )

Minimum pension liability adjustment—net

     (89 )     (12 )
                

Comprehensive loss including noncontrolling interests

   $ (599 )   $ (87 )

Comprehensive income attributable to noncontrolling interests

     (8 )     (64 )
                

Comprehensive loss attributable to Nortel Networks Corporation

   $ (607 )   $ (151 )
                

 

(a) Certain securities deemed available-for-sale by Nortel were measured at fair value. Unrealized holding losses related to these securities were excluded from net loss and are included in accumulated other comprehensive loss until realized. Unrealized loss on investments was net of tax of nil for the three months ended March 31, 2009 and 2008, respectively.

17. Share-based compensation plans

On February 27, 2009, Nortel obtained Canadian Court approval to terminate its equity-based compensation plans (2005 SIP, 1986 Plan and 2000 Plan) and certain equity-based compensation plans assumed in prior acquisitions, including all outstanding equity under these plans (stock options, SARs, RSUs and PSUs), whether vested or unvested. Nortel sought this approval given the decreased value of NNC common shares and the administrative and associated costs of maintaining the plans to itself as well as the plan participants. As a result of the cancellation of the plans, $91 of the remaining unrecognized compensation cost for unvested awards has been recognized as compensation cost in the first quarter of 2009, in addition to $10, attributable to share-based compensation cost in the normal course.

 

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Nortel did not grant any share-based awards during the quarter ended March 31, 2009. The following denotes activity under the plans from December 31, 2008 through February 27, 2009, the date of termination of the plans.

Stock options

The following is a summary of the total number of outstanding stock options and the maximum number of stock options available for grant:

 

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

Balance at December 31, 2008

   29,418     $ 56.00    5.8    $ —      22,026  

Options forfeited

   (607 )   $ 13.69       $ —      2,614  

Options expired

   (487 )   $ 127.73       $ —      473  

Options cancelled

   (28,324 )   $ 54.93       $ —      (25,113 )
                               

Balance as of March 31, 2009

   —       $ —      —      $ —      —    
                               

RSUs

The following is a summary of the total number of outstanding share-based RSU awards 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, 2008

   5,000     $ 13.05    2.1

Awards forfeited

   (264 )     14.62   

Awards cancelled

   (4,736 )     12.96   
                 

Balance as of March 31, 2009

   —       $ —      —  
                 

 

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

PSUs

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

The following is a summary of the total number of outstanding share-based PSU-rTSRs 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, 2008

   1,554     $ 14.47    1.3

Awards forfeited

   (1,554 )     14.47   
                 

Balance as of March 31, 2009

   —       $ —      —  
                 

 

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

 

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

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

 

     PSU-Management OM
     Awards
Granted
(Thousands)
    Weighted-
Average
Grant Date
Fair Value
   Weighted -
Average
Contractual
Life

(In Years)

Balance as of December 31, 2008

   1,223     $ 7.91    2.0

Awards forfeited

   (189 )     8.05   

Awards cancelled

   (1,034 )     7.89   
                 

Balance as of March 31, 2009

   —       $ —      —  
                 

Share-based compensation

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

 

     Three Months Ended
March 31,
       2009        2008  

Share-based compensation expense:

     

Deferred Share Units

   $ —      $ —  

Stock options

     53      11

RSU

     40      8

RSU PSU-rTSRs

     7      2

PSU PSU-Management OMs

     1      —  
             

Total share-based compensation expense

   $ 101    $ 21
             

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

 

     Three Months
Ended March 31,
2008

Black-Scholes Merton assumptions

  

Expected dividend yield

   0.00%

Expected volatility

   44.21% - 52.26%

Risk-free interest rate

   2.44% - 2.51%

Expected life in years

   3.15 - 4.50

Range of fair value per stock option granted

   $3.07 - $3.76

Range of fair value per SAR granted

   $0.20 - $2.30

Nortel estimates the fair value of PSU-rTSR awards using a Monte Carlo simulation model. Certain assumptions used in the model to value awards granted in the three months ended March 31, 2008 include (but are not limited to) the following:

 

     Three Months
Ended March 31,
2008
 

Monte Carlo assumptions

  

Historical volatility

   43.96 %

Expected volatility (b) Risk-free interest rate

   1.64 %

 

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Cash received from exercise under all share-based payment arrangements was nil for the three months ended March 31, 2009 and 2008. Tax benefits realized by Nortel related to these exercises were nil for the three months ended March 31, 2009 and 2008.

18. Liabilities subject to compromise

As described in note 2, as a result of the Creditor Protection Proceedings, pre-petition liabilities may be subject to compromise or other treatment and generally, actions to enforce or otherwise effect payment of pre-petition liabilities are stayed. Although pre-petition claims are generally stayed, under the Creditor Protection Proceedings, the Debtors are permitted to undertake certain actions designed to stabilize the Debtors’ operations including, among other things, payment of employee wages and benefits, maintenance of Nortel’s cash management system, satisfaction of customer obligations, payments to suppliers for goods and services received after the Petition Date and retention of professionals.

SOP 90-7 requires pre-petition liabilities of the debtor that are subject to compromise to be reported at the claim amounts expected to be allowed, even if they may be settled for lesser amounts. The amounts currently classified as liabilities subject to compromise may be subject to future adjustments depending on actions of the applicable courts, further developments with respect to disputed claims, determinations of the secured status of certain claims, if any, the values of any collateral securing such claims, or other events.

Liabilities subject to compromise consist of the following:

 

     March 31, 2009

Trade and other accounts payable

   $ 584

Restructuring liabilities

     167

Long-term debt

     4,402

Pension obligations

     1,610

Postretirement obligations other than pensions

     510

Other accrued liabilities

     347

Other

     71
      

Total liabilities subject to compromise

   $ 7,691
      

19. 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.

 

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Transactions with related parties for the three months ended March 31 are summarized as follows:

 

     Three Months Ended March 31,
           2009                2008      

Revenues:

     

LGE (a)

   $ 3    $ 11

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

     2      4

Other

     2      2
             

Total

   $ 7    $ 17
             

Purchases:

     

LGE (a)

     18      52

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

     —        5

GNTEL Co., Ltd (“GNTEL”) (d)

     13      24

Other

     3      6
             

Total

   $ 34    $ 87
             

 

(a) LGE holds a noncontrolling interest in LGN. Nortel’s sales and purchases relate primarily to certain inventory-related items. As of March 31, 2009, accounts payable to LGE was net $12, compared to net $45 as of December 31, 2008.
(b) LGN currently owns a noncontrolling interest in Vertical. Vertical supports LGN’s efforts to distribute Nortel’s products to the North American market.
(c) Nortel’s purchases from Sasken related primarily to software and other software development-related purchases. The relationship was terminated in during 2008.
(d) Nortel holds a noncontrolling interest in GNTEL through its business venture LGN. Nortel’s purchases from GNTEL relate primarily to installation and warranty services. As of March 31, 2009, accounts payable to GNTEL was net $13, compared to net $14 as of December 31, 2008.

As of March 31, 2009 and December 31, 2008, accounts receivable from related parties were $8 and $19, respectively. As of March 31, 2009 and December 31, 2008, accounts payable to related parties were $27 and $71, respectively.

20. Contingencies

Creditor Protection Proceedings

Generally, as a result of the Creditor Protection Proceedings, all actions to enforce or otherwise effect payment or repayment of liabilities of any Debtor preceding the Petition Date, as well as pending litigation against any Debtor, are stayed as of the Petition Date. Absent further order of the applicable courts and subject to certain exceptions, no party may take any action to recover on pre-petition claims against any Debtor.

U.S. Federal Grand Jury Subpoenas

In May 2004 and August 2005, Nortel received federal grand jury subpoenas for the production of certain documents in connection with a criminal investigation being conducted by the U.S. Attorney’s Office for the Northern District of Texas, Dallas Division. Nortel understands that this investigation of NNI and certain former employees has been concluded, and it has been advised that no criminal charges will be filed in the U.S. in connection with this matter.

 

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ERISA Lawsuit

Beginning in December 2001, Nortel, together with certain of its then-current and former directors, officers and employees, were 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.

Canadian Pension Class Action

On June 24, 2008, a purported class action lawsuit was filed against Nortel and NNL 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) or common law notification requirements. The plaintiffs seek declaratory and equitable relief, and unspecified monetary damages.

Nortel Statement of Claim Against its Former Officers

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, Nortel’s 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. One-half of any recovery from this litigation is subject to the Global Class Action Settlement referenced in note 22 of the 2008 Annual Report.

Former Officers’ Statements of Claims Against Nortel

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. Mr. Dunn has further brought an application before the Ontario Superior Court of Justice against Nortel and NNL seeking an order that, pursuant to its by-laws, Nortel reimburse him for all past and future defense costs he has incurred as a result of proceedings commenced against him by reason of his being or having been a director or officer of Nortel.

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.

Ipernica

In June 2005, Ipernica Limited (formerly known as QSPX Development 5 Pty Ltd), an Australian patent holding firm, filed a lawsuit against Nortel in the U.S. District Court for the Eastern District of Texas alleging patent infringement. In April 2007, the jury reached a verdict to award damages to Ipernica in the amount of $28. In March 2008, Nortel entered into an agreement to settle all claims, which grants to Nortel a perpetual, world-wide license to various Ipernica patents, and includes a covenant not to sue as well as mutual releases. In connection with this settlement, a payment of $12 was made by NNI to Ipernica in the first quarter of 2008.

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

 

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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. 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 Ipernica settlement, Nortel intends to defend the above actions, suits, claims and proceedings in which it is a defendant, 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 regulatory and criminal investigations.

Nortel is also a defendant in various other suits, claims, proceedings and investigations that arise in the normal course of business.

Environmental matters

Nortel’s business is subject to a wide range of continuously evolving environmental laws in various jurisdictions. Nortel seeks to operate its business in compliance with these changing laws and regularly evaluates their impact on operations, products and facilities. Existing and new laws may cause Nortel to incur additional costs. In some cases, environmental laws affect Nortel’s ability to import or export certain products to or from, or produce or sell certain products in, some jurisdictions, or have caused it to redesign products to avoid use of regulated substances. Although costs relating to environmental compliance have not had a material adverse effect on the business, results of operations, financial condition or liquidity to date, there can be no assurance that such costs will not have a material adverse effect going forward. Nortel continues to evolve compliance plans and risk mitigation strategies relating to the new laws and requirements. Nortel intends to design and manufacture products that are compliant with all applicable legislation and meet its quality and reliability requirements.

Nortel has a corporate environmental management system standard and an environmental program to promote such compliance. Moreover, Nortel has a periodic, risk-based, integrated environment, health and safety audit program. Nortel’s environmental program focuses its activities on design for the environment, supply chain and packaging reduction issues. Nortel works with its suppliers and other external groups to encourage the sharing of non-proprietary information on environmental research.

Nortel is exposed to liabilities and compliance costs arising from its past generation, management and disposal of hazardous substances and wastes. As of March 31, 2009, the accruals on the condensed combined and consolidated balance sheet for environmental matters were $11. Based on information available as of March 31, 2009, management believes that the existing accruals are sufficient to satisfy probable and reasonably estimable environmental liabilities related to known environmental matters. Any additional liabilities that may result from these matters, and any additional liabilities that may result in connection with other locations currently under investigation, are not expected to have a material adverse effect on the business, results of operations, financial condition and liquidity of Nortel.

Nortel has remedial activities under way at 11 sites that are either currently or previously owned or occupied facilities. An estimate of Nortel’s anticipated remediation costs associated with all such sites, to the extent probable and reasonably estimable, is included in the environmental accruals referred to above.

Nortel is also listed as a potentially responsible party under the U.S. Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) at four Superfund sites in the U.S. At three of the Superfund sites, Nortel is considered a de minimis potentially responsible party. A potentially responsible party within the meaning of CERCLA i