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Nortel Networks 10-Q 2012 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended March 31, 2012 OR
For the Transition Period From to Commission File Number: 001-07260
Nortel Networks Corporation (Exact name of registrant as specified in its charter)
Registrants 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 x 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.
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 issuers classes of common stock as of March 31, 2012. 498,206,366 shares of common stock without nominal or par value
Table of ContentsTABLE OF CONTENTS
All dollar amounts in this document are in United States Dollars unless otherwise stated. NORTEL, NORTEL (Logo), NORTEL NETWORKS, the Globemark, and NT are trademarks of Nortel Networks. All other trademarks are the property of their respective owners.
Table of ContentsPART 1 FINANCIAL INFORMATION
NORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Condensed Consolidated Statements of Operations (unaudited) (Millions of U.S. Dollars, except per share amounts)
The accompanying notes are an integral part of these condensed consolidated financial statements
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Condensed Consolidated Balance Sheets (unaudited) (Millions of U.S. Dollars, except share amounts)
The accompanying notes are an integral part of these condensed consolidated financial statements
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Condensed Consolidated Statements of Comprehensive Loss (unaudited) (Millions of U.S. Dollars)
The accompanying notes are an integral part of these condensed consolidated financial statements
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Condensed Consolidated Statements of Cash Flows (unaudited) (Millions of U.S. Dollars)
The accompanying notes are an integral part of these condensed consolidated financial statements
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Notes to Condensed Consolidated Financial Statements (unaudited) 1. Basis of presentation All monetary amounts in these notes to the unaudited condensed consolidated financial statements are in millions, except per share amounts, and in United States (U.S.) Dollars unless otherwise stated. Nortel Networks Corporation Prior to Nortel Networks Corporations (Nortel, NNC, or the Company) significant business divestitures, NNC was a global supplier of end-to-end networking products and solutions serving both service providers and enterprise customers. Nortels technologies spanned access and core networks and support multimedia and business-critical applications. Nortels networking solutions consisted of hardware, software and services. Nortel designed, developed, engineered, marketed, sold, licensed, installed, serviced and supported these networking solutions worldwide. As further discussed in note 2, Nortel is currently focused on the remaining work under the Creditor Protection Proceedings (as defined in note 2), including providing transitional services to the purchasers of Nortels businesses, ongoing restructuring matters and the sale of any remaining assets. As of March 31, 2012, Nortel has completed the sales of all of its businesses, and regarding these businesses, only the residual contracts not transferred to the various buyers remain. Commencing with the first quarter of 2011, Nortel has one reportable segment, being the consolidated entity, as its chief operating decision maker reviews financial and operating results on that basis. Nortel Networks Limited (NNL) is Nortels principal direct operating subsidiary and its results are consolidated into Nortels results. Nortel holds all of NNLs outstanding common shares but none of its outstanding preferred shares. NNLs preferred shares are reported in noncontrolling interests in the consolidated balance sheets and dividends accrued on preferred shares are reported in income attributable to noncontrolling interests in the statements of operations. Nortel does not expect to pay any of these cumulative dividends as a result of the Creditor Protection Proceedings. Basis of Presentation and Going Concern Considerations The unaudited condensed consolidated financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP) and do not include all the information and notes required in the preparation of annual consolidated financial statements. The accounting policies used in the preparation of the unaudited condensed consolidated financial statements are the same as those described in Nortels audited consolidated financial statements prepared in accordance with U.S. GAAP for the year ended December 31, 2011. The unaudited condensed consolidated balance sheet as of December 31, 2011 is derived from the December 31, 2011 audited consolidated financial statements. Although Nortel is headquartered in Canada, the unaudited condensed consolidated financial statements are expressed in U.S. Dollars as the greater part of Nortels 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 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, employee benefits including pensions, taxes and related valuation allowances and provisions, restructuring and other provisions, contingencies and pre-petition liabilities. 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, 2012 are not necessarily indicative of financial results for the full year or for any other quarter. The unaudited condensed consolidated financial statements should be read in conjunction with Nortels Annual Report on Form 10-K for the year ended December 31, 2011 filed with the U.S. Securities and Exchange Commission (SEC) and Canadian securities regulatory authorities (2011 Annual Report) and this Quarterly Report on Form 10-Q for the three months ended March 31, 2012. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 852 Reorganization (ASC 852), which is applicable to companies that have filed petitions under applicable bankruptcy code provisions and as a result of the Creditor Protection Proceedings is applicable to Nortel, 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, Nortels revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the Creditor Protection Proceedings must be reported separately as reorganization items in the statements of operations. 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 ASC 852 effective on January 14, 2009 and has segregated those items outlined above for all reporting periods subsequent to such date.
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Table of ContentsAfter consideration of the guidance available in ASC 810 Consolidation (ASC 810) and ASC 852, the unaudited condensed consolidated financial statements as of March 31, 2012 and December 31, 2011, and for three months ended March 31, 2012 and 2011 have been presented on the following basis with respect to Nortel subsidiaries:
Nortel continues to exercise control over its subsidiaries located in Canada, Central America and Latin America (CALA) and Asia (other than those entities that are EMEA Subsidiaries, U.S. Subsidiaries or have been placed in liquidation proceedings), and its financial statements are prepared on a consolidated basis with respect to those subsidiaries. Nortel will continue to evaluate its remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress. Beginning on January 14, 2009 (the Petition Date), Nortel and certain of its subsidiaries in Canada, the U.S., and in certain EMEA countries filed for creditor protection under the relevant jurisdictions of Canada, the U.S., the United Kingdom (U.K.) and subsequently commenced separate proceedings in Israel, followed by secondary proceedings in France. The unaudited condensed consolidated financial statements do not purport to reflect or provide for the consequences of the Creditor Protection Proceedings. In particular, such unaudited condensed 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 Nortels capitalization; or (d) as to divestiture proceeds held in escrow and recorded by NNL solely for financial reporting purposes, the final allocation of these proceeds as between various Nortel legal entities, including entities that are not consolidated in these unaudited condensed consolidated financial statements, which will ultimately be determined either by joint agreement or through a dispute resolution proceeding (see note 2). The ongoing Creditor Protection Proceedings and the divestitures of Nortels businesses and assets, both completed and those asset sales that may arise in the future raise substantial doubt as to whether Nortel will be able to continue as a going concern. While the Debtors (as defined in note 2) have filed for and been granted creditor protection, the unaudited condensed 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. However, it is not possible to predict the outcome of the Creditor Protection Proceedings and, as such, there is substantial doubt regarding the realization of assets and discharge of liabilities. If the going concern basis is not appropriate, adjustments will be necessary to the carrying amounts and/or classification of Nortels assets and liabilities. Further, a court approved plan in connection with the Creditor Protection Proceedings could materially change the carrying amounts and classifications reported in the unaudited condensed consolidated financial statements. Nortel will continue to evaluate its remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress. Comparative Figures Certain 2011 figures in the unaudited condensed consolidated financial statements have been reclassified to conform to Nortels current period presentation. 2. Creditor protection proceedings On the Petition Date, after extensive consideration of all other alternatives, with the unanimous authorization of the Nortel board of directors after thorough consultation with its advisors, certain Nortel entities, including NNC and NNL, initiated creditor protection proceedings in multiple jurisdictions under the respective restructuring regimes of Canada, under the Companies Creditors Arrangement Act (CCAA) (CCAA Proceedings), the U.S. under Chapter 11 of the U.S. Bankruptcy Code (Chapter 11) (Chapter 11 Proceedings), U.K. under the Insolvency Act 1986 (U.K. Administration Proceedings), and subsequently, Israel under the Israeli Companies Law 1999 (Israeli Administration Proceedings). On May 28, 2009, one of Nortels French subsidiaries, NNSA was placed into secondary proceedings (French Secondary Proceedings). The CCAA Proceedings, Chapter 11 Proceedings, U.K. Administration Proceedings, Israeli Administration Proceedings and French Secondary Proceedings are together referred to as the Creditor Protection Proceedings. On July 14, 2009, Nortel Networks (CALA) Inc. (NNCI), a U.S. based subsidiary with
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Table of Contentsoperations in the CALA region, also filed a voluntary petition for relief under Chapter 11 in the U.S. Bankruptcy Court for the District of Delaware (U.S. Court) and became a party to the Chapter 11 Proceedings. Nortel initiated the Creditor Protection Proceedings with a consolidated cash balance, as of December 31, 2008, of approximately $2,400, in order to preserve its liquidity and fund operations during the process. As used herein: Bondholder Group means a group purporting to hold a portion of our publicly traded debt; Canadian Monitor means Ernst & Young Inc. as court-appointed monitor in the CCAA Proceedings; Debtors means: (i) Nortel, together with NNL and certain other Canadian subsidiaries (collectively, Canadian Debtors) that filed for creditor protection pursuant to the provisions of the CCAA in the Ontario Superior Court of Justice (Canadian Court); (ii) Nortel Networks Inc. (NNI), Nortel Networks Capital Corporation (NNCC), NNCI and certain other U.S. subsidiaries (collectively, U.S. Debtors) that have filed voluntary petitions under Chapter 11 in the U.S. Court; (iii) the EMEA Debtors that made consequential filings under the Insolvency Act 1986 in the High Court of England and Wales (English Court) (including NNSA); and certain Israeli subsidiaries (collectively, Israeli Debtors) that made consequential filings under the Israeli Companies Law 1999 in the District Court of Tel Aviv; French Liquidator means the liquidator appointed by the Versailles Commercial Court in secondary insolvency proceedings commenced by Nortel Networks SA in France; U.K. Administrators means, correctively, a representative of Ernst & Young LLP (in the U.K.) and a representative of Ernst & Young Chartered Accountants (in Ireland) as court-appointed joint administrators of Nortel Networks (Ireland) Ltd. (NNIL) and representatives of Ernst & Young LLP (in the U.K.) as court-appointed joint administrators of the EMEA Debtors other than NNIL; U.S. Creditors Committee means the Official Committee of Unsecured Creditors of the U.S. Debtors appointed in the Chapter 11 Proceedings; U.S. Principal Officer means the principal officer of the U.S. Debtors appointed in the Chapter 11 Proceedings; and U.S. Trustee means the United States Trustee for the District of Delaware. For further information regarding prior developments in connection with the Creditor Protection Proceedings, refer to Nortels 2011 Annual Report. Significant Business Divestitures In June, 2009, Nortel determined that selling its businesses was the best path forward. Nortel has completed divestitures of all of its businesses including: (i) the sale of substantially all of its Code Division Multiple Access (CDMA) business and Long Term Evolution (LTE) Access assets to Telefonaktiebolaget LM Ericsson (Ericsson); (ii) the sale of substantially all of the assets of its Enterprise Solutions (ES) business globally, including the shares of Nortel Government Solutions Incorporated (NGS) and DiamondWare, Ltd. (Diamondware), to Avaya Inc. (Avaya); (iii) the sale of the assets of its Wireless Networks (WN) business associated with the development of Next Generation Packet Core network components (Packet Core Assets) to Hitachi, Ltd. (Hitachi); (iv) the sale of certain portions of its Layer 4-7 data portfolio to Radware Ltd.; (v) the sale of substantially all of the assets of its Optical Networking and Carrier Ethernet businesses to Ciena Corporation (Ciena); (vi) the sale of substantially all of the assets of its Global System for Mobile communications (GSM)/GSM for Railways (GSM-R) business to Ericsson and Kapsch CarrierCom AG (Kapsch); (vii) the sale of substantially all of the assets of its Carrier VoIP and Application Solutions (CVAS) business to GENBAND Inc. (now known as GENBAND U.S. LLC (GENBAND)); (viii) the sale of NNLs 50% plus one share interest in LG-Nortel Co. Ltd. (LGN), its Korean joint venture with LG Electronics, Inc. (LGE), to Ericsson; (ix) the sale of substantially all of the assets of its global Multi Service Switch (MSS) business to Ericsson; (x) the sale of substantially all of the assets of Guangdong-Nortel Telecommunications Equipment Co. Ltd. (GDNT), to Ericsson Mobile Data Applications Technology Research and Development Guangzhou Company Limited and Ericsson (Guangdong Shunde) Communications Company Limited (collectively, Ericsson China); (xi) the sale of its remaining patents and patent applications to a consortium consisting of Apple Inc., EMC Corporation, Ericsson, Microsoft Corporation, Research in Motion Limited and Sony Corporation (collectively the Consortium); and (xii) the sale of a small number of its Internet Protocol version 4 addresses to various purchasers. One of the key remaining matters under the Creditor Protection Proceedings is the determination of allocation of sale proceeds among the various Nortel legal entities that participated in the sales of Nortels businesses, which include entities subject to the respective Creditor Protection Proceedings in the different jurisdictions as well as entities that are not subject to any court supervision or proceedings. Divestiture Proceeds Received As of March 31, 2012, approximately $7,800 in net proceeds have been generated and received through the completed sales of businesses and remaining patents and patent applications. These divestiture proceeds include the following approximate amounts:
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As of March 31, 2012, $7,320 of proceeds received from divestitures of businesses and remaining patents and patent applications is being held in escrow and an additional $229, representative of proceeds from the sale of LGN, is included in non-current restricted cash and cash equivalents, all of which is currently reported in NNL solely for financial reporting purposes (including with respect to any gain recorded on such divestitures). The difference between the net proceeds received and the amount in escrow at March 31, 2012 is as a result of amounts that, from time to time, have been distributed, with the consent of each of the Debtors estates and court approvals, as applicable from the escrow accounts to satisfy: 1) various obligations arising from the divestitures, whether through payments to third party vendors, or to reimburse the Debtors or non-consolidated subsidiaries for costs incurred, or 2) payments to the Debtors or non-consolidated subsidiaries related to settlements reached in respect of certain agreements involving proceeds allocation. The ultimate determination of the final allocation of such proceeds among the various Nortel legal entities, including entities that are not consolidated in these financial statements, has not yet occurred and may be materially different from the NNL classification and related amounts shown in these financial statements. The Interim Funding and Settlement Agreement (IFSA) and the escrow agreements for sales divestiture proceeds entered into by NNL, NNI and other Nortel legal entities provide for the processes for determining the final allocation of divestiture proceeds among such entities, either through joint agreement or, failing such agreement, other dispute resolution proceedings. Adjustments to the NNL classification and any related amounts arising from the ultimate allocation will be recognized when finalized. The NNL classification and related amounts shown in these financial statements are not determinative of, and have not been accepted by any debtor estate, any party in interest in the Creditor Protection Proceedings or any court overseeing such proceedings, for purposes of deciding the final allocation of divestiture proceeds. During the three months ended March 31, 2012, Nortel received additional proceeds of $70 that had been held in escrow subject to the successful completion of performance obligations under the transition services agreements (TSAs) entered into in connection with the sale of substantially all of Nortels CDMA business, LTE Access assets, and CVAS business, and its North American GSM business, all of which were recorded as gain on divestitures included in reorganization items net. As of March 31, 2012, a further $27 in connection with the divestitures of substantially all of the assets of Nortels Optical Networking and Carrier Ethernet businesses, CVAS business, and substantially all of the assets of Nortels MSS business, is currently unrecorded and will be recognized subject to agreement between Nortel and each of the various buyers that obligations under the TSAs have been completed. Such amounts, when and if received, will also be held in escrow until the final allocation of these proceeds as between various Nortel legal entities, including the U.S. and EMEA subsidiaries, is ultimately determined. Allocation of Divestiture Proceeds and Other Inter-Estate Matters At various times during the second half of 2009 and the first quarter of 2010, the Canadian Debtors, the U.S. Debtors and the U.K. Administrators, with the involvement of the Canadian Monitor, the U.S. Principal Officer, the U.S. Creditors Committee and the Bondholder Group engaged in negotiations regarding the scope and terms of a proposed protocol for resolving disputes concerning the allocation of sale proceeds (Allocation Protocol), as required by the terms of the IFSA. However, it became apparent that the parties had differing views concerning the allocation of the sale proceeds, inter-company claims and the scope of the Allocation Protocol. In order to address this impasse, the Canadian Debtors, the U.S. Debtors and the U.K. Administrators agreed to temporarily suspend negotiations on the Allocation Protocol and instead focused on a process to facilitate a comprehensive settlement to resolve all material outstanding inter-estate matters, including the allocation of the sale proceeds and the settlement of inter-company claims. To this end, the parties met on several occasions to outline, on a confidential and without prejudice basis, their respective allocation methodologies and potential inter-company claims that may be asserted. As a result of these meetings and the complexity of the issues that were raised, the Canadian Debtors, the U.S. Debtors, the EMEA Debtors, the U.K. Administrators, the Canadian Monitor the U.S. Principal Officer, the U.S. Creditors Committee, the Bondholder Group and certain other interested parties (collectively, the Mediation Parties) agreed that these inter-estate negotiations would be aided by the appointment of a neutral mediator to review and mediate the issues. The parties selected Layn R. Phillips, a former U.S. federal district court judge and experienced commercial mediator, to serve as mediator and review the positions and viewpoints of the various parties on allocation and unresolved inter-estate matters. A confidential, non-binding mediation was held in November 2010. The mediation session did not result in the resolution of the issues presented.
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Table of ContentsAs a result of the November 2010 mediation session, and positions taken in the CCAA Proceedings, it became apparent that the U.K. Administrators and certain other parties, who were also substantial creditors of the EMEA Debtors, were alleging a number of significant potential claims against the Canadian Debtors as well as the U.S. Debtors. These potential claims were integral to the allocation positions of these parties and included allegations of proprietary and trust-type claims. Consequently, the Canadian Monitor and the Canadian Debtors determined that, absent reaching a comprehensive settlement of allocation and inter-company claims issues, these specific claims needed to be resolved first. Accordingly, the Canadian Debtors obtained an order of the Canadian Court establishing a process for the calling of claims from EMEA creditors. Notwithstanding the commencement of this process, the Mediation Parties continued to engage in discussions regarding the resumption of mediation and another confidential, non-binding mediation was held in April 2011. On April 13, 2011, Nortel announced that the mediation process that had been commenced in respect of the allocation of sale proceeds of its various business and asset divestitures and other inter-estate matters, including inter-company claims, had ended without resolution of the matters in dispute. In light of the unsuccessful conclusion of the mediation process, Nortel announced that delays in the ultimate resolution of allocation and inter-company claims matters potentially could be significant, and that such delays would result in a corresponding significant delay in the timing of distributions to holders of validated claims of the various estates. On April 25, 2011, the U.S. Debtors and the U.S. Creditors Committee filed a joint motion for an order establishing an allocation protocol for the sale proceeds as between various Nortel legal entities (Original Protocol Motion), and for related relief. Subsequently, as a result of further discussions, the U.S. Debtors and the U.S. Creditors Committee together with the Canadian Debtors jointly filed an amended and restated version of the Original Protocol Motion and agreed to collectively seek an order establishing an allocation protocol before the Canadian Court and the U.S. Court. The proposed order would have had the U.S. Court and the Canadian Court establish procedures and an expedited schedule for the cross-border resolution by the U.S. Court and the Canadian Court on the allocation of proceeds from the sales of Nortels businesses and from the sale of its patent portfolio. The motion was heard at a joint hearing of the U.S. Court and Canadian Court on June 7, 2011. On June 20, 2011, Nortel announced that the Canadian Court and the U.S. Court had reserved their decisions on the motions heard by such courts on June 7, 2011, and directed NNC, NNL and the other Canadian Debtors, NNI and the other U.S. Debtors, the EMEA Debtors, as well as certain other parties, to participate in a joint mediation of the issues raised in the motions. The directions provided that the Canadian Court and the U.S. Court together would appoint a sole mediator by supplemental order and that the mediator would determine the time, date, place and protocol of the mediation. On June 17, 2011, and as supplemented on June 29, 2011, the Canadian Court and the U.S. Court appointed The Honourable Warren K. Winkler, Chief Justice of Ontario, as the sole mediator (the Mediator) for the mediation. The mediation was ordered because of both courts concern that the time required to prepare their decisions would also delay allocation proceedings and, therefore, distributions to creditors of the various Nortel estates. The Mediator has the authority, in consultation with the parties to the mediation, to determine the scope of the mediation, as he deems appropriate, including the issue of allocation of the sale proceeds of Nortels various businesses and patent portfolio, and global issues relating to allocation and claims. Participation in this mediation is mandatory. The mediation process will be terminated (i) by a declaration by the Mediator that a settlement has been reached (any such settlement would be subject to the approval of the Canadian Court and the U.S. Court, on notice to parties in interest), (ii) by a declaration by the Mediator that further efforts at mediation are no longer considered worthwhile, or (iii) for any other reason as determined by the Mediator. At the request of the U.S. Court, the commencement of the mediation was delayed pending the outcome of the October 14, 2011 hearing (discussed in more detail below). The Canadian Court approved a claims process with regard to the significant inter-company claims made by the EMEA Debtors against the Canadian Debtors, which process included a requirement that claims be filed by March 18, 2011. In response to this call for claims, representatives of the U.K. Administrators, on behalf of the EMEA Debtors, filed 84 proofs of claims against the Canadian Debtors and unspecified directors and officers of NNC and NNL (the EMEA Claims). The EMEA Claims contain broad ranging claims set out with limited specificity. The EMEA Claims also include a number of large priority claims, which if allowed, would significantly reduce the potential proceeds available for distribution to unsecured creditors of the Canadian Debtors. Nortel is currently unable to quantify the total potential amounts claimed under the EMEA Claims, as many of the claims were not quantified. The EMEA Claims that were quantified total approximately CAD$9.8 billion. In addition, the U.K. Pension Trust Limited and the Board of the Pension Protection Fund in the U.K. filed an estimated claim of CAD$3.7 billion in respect of an alleged deficit in the U.K. pension plan (the U.K. Pension Claim). Should the EMEA Claims and the U.K. Pension Claim ultimately be allowed in the CCAA Proceedings on the basis filed, they could have the effect of doubling (or more) the otherwise estimated CCAA claims pool and, accordingly, significantly reduce potential distributions to other unsecured creditors of the Canadian Debtors. Further, counsel for 131 former employees of NNSA have submitted a letter indicating they would file proofs of claims in connection with an action that is currently before the courts in France. On September 30, 2009, the EMEA Debtors and certain of their affiliates (collectively the EMEA Original Claimants) filed over 350 proofs of claim against the U.S. Debtors and unspecified directors and officers of the U.S. Debtors in the U.S. Court. On May 10, 2011, the U.S. Court entered an order requiring the EMEA Original Claimants to file more definite statements of their previously-filed claims, and to file any other pre-petition claims against the U.S. Debtors, by June 1, 2011, absent which any of their pre-petition claims would be disallowed. The deadline for filing amended proofs of claim was later extended on request of certain of the EMEA Original Claimants to June 3, 2011 (U.S. EMEA Claims Bar Date). The EMEA Original Claimants filed 38 amended proofs of claim on June 3, 2011. The remaining proofs of claim that had been filed by the EMEA Original Claimants and were not amended on a timely basis have been disallowed and expunged pursuant to the terms of the U.S. Courts May 10, 2011 order.
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Table of ContentsOn July 15 and 22, 2011, the U.S. Debtors and the U.S. Creditors Committee filed joint objections and motions to dismiss the claims of NNUK, NNSA and Nortel Networks (Ireland) Limited and the French Liquidator (collectively, the EMEA Claimants). On August 3, 2011, the U.S. Court issued an order that set October 13 and 14, 2011 as the hearing dates for these motions. The order also requested the Mediator to consider postponing the mediation discussed above until after these hearings and the U.S. Courts decision on the motions to dismiss. On August 9, 2011, the Mediator advised the parties to the mediation that he was postponing the initial procedural meeting to a date to be determined after the U.S. Court releases its decision. The U.S. Court heard the motions on October 14, 2011. On March 20, 2012, the U.S. Court granted the U.S. Debtors and U.S. Creditors Committees motion to dismiss these EMEA Claimants breach of duty of care and other fiduciary duty claims, claims of mismanagement under French law, and the contingent claims arising from the issuance of any financial support direction with respect to the U.K. Pension Plan. The U.S. Court declined to dismiss the remaining claims of these EMEA Claimants at this stage of the proceedings. However, the U.S. Court noted that the arguments raised in the motions were persuasive in showing the weakness and unlikelihood of success of these claims. The decision further noted that the parties dispute will now move to mediation, as noted above. Following the U.S. Courts March 20, 2012 decision, pursuant to a letter dated March 26, 2012 from the Mediator to all parties to the mediation, an introductory mediation session was held on April 24, 2012 whereby mediation parties had the opportunity to meet privately with the Mediator. The Mediator advised that he will continue to hold meetings with individual parties to the mediation in his efforts to work towards a resolution on allocation matters. The Mediator is posting updates of a general nature regarding the mediation, as appropriate, on a website at www.nortelmediation.com. The content of this website is not a part of this report. Developments in the Creditor Protection Proceedings Since the filing of Nortels 2011 Annual Report, the following are the material developments in the sales of its assets and in the Creditor Protection Proceedings. CCAA Proceedings On the Petition Date, the Canadian Debtors obtained an initial order from the Canadian Court for creditor protection for 30 days, pursuant to the provisions of the CCAA, which has since been extended from time to time and most recently to July 31, 2012 and is subject to further extensions by the Canadian Court. Chapter 11 Proceedings On June 21, 2010, the U.S. Debtors filed a motion seeking to terminate certain U.S. retiree and long-term disability (LTD) benefits effective as of August 31, 2010. The U.S Debtors filed a notice of withdrawal of this motion with the U.S. Court on July 16, 2010. In anticipation that the U.S. Debtors will seek modification or termination of some or all of the U.S. retiree and LTD benefits at a later time, on June 21, 2011, upon the motion of the U.S. Debtors dated June 2, 2011, the U.S. Court entered an order directing the U.S. Trustee to establish a committee of retirees for the U.S. Debtors to consult with before undertaking any modification or termination of the U.S. retiree benefits. Additionally, on June 22, 2011, the U.S. Court entered an order directing the U.S Trustee to establish a committee of LTD employees for the U.S. Debtors to consult with before undertaking any modification or termination of the U.S. LTD benefits. On August 2, 2011, the U.S. Trustee appointed the members of these committees. Upon the motion of the U.S. Debtors dated March 28, 2012, on April 18, 2012, the U.S. Court appointed a neutral mediator to mediate discussions between the U.S Debtors, the U.S. Creditors Committee, the Bondholder Group and the retiree and LTD committees regarding a future modification or termination of U.S. retiree and LTD benefits. Internet Protocol Addresses Nortel commenced a process, approved by the Canadian Court, to sell certain residual IT assets primarily consisting of about 17 million Internet Protocol version 4 addresses (IP Addresses) and IT hardware assets including 700 servers. Working together with the Canadian Monitor, Nortels goal is to maximize the value of these residual IT assets in a timely manner. Any definitive sale agreement will require approval of the Canadian Court. On February 17, 2012, the Canadian Court approved two sale agreements that NNL and Nortel Networks Technology Corporation (NNTC) had entered into for the sale of rights in a small number of Nortels IP Addresses. Under one sale agreement, CSC Holdings LLC, the operating subsidiary of Cablevision Systems Corporation, is the purchaser of a certain number of the IP Addresses, and under the other sale agreement, Salesforce.com Inc. is the purchaser of a certain number of the IP Addresses. The financial and other terms of each of the sale agreements, including the cash purchase price and the IP Addresses included in each sale, have been sealed by order of the Canadian Court because disclosure of such terms may be detrimental to the Canadian Debtors interests in seeking to consummate these and other sales of IP Addresses. Both purchasers have obtained approval from the American Registry for Internet Numbers (ARIN) with respect to the transfer and registration of the IP Addresses in the respective purchasers name upon closing. Nortel closed these sales in the first quarter of 2012 and the proceeds from the transactions have been deposited into an NNL single purpose bank account. The Canadian Debtors and the U.S. Debtors have agreed that any dispute relating to the rights and claims, if any, of the U.S. Debtors in and to the IP Addresses, including to an allocation of such sale proceeds, will be subject to a joint hearing of the Canadian Court and the U.S. Court prior to the distribution of such sale proceeds and, if appropriate, orders of such courts approving such distributions.
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Table of ContentsOn April 4, 2012, the Canadian Court approved a further sale agreement that NNL and NNTC had entered into with Bell Aliant Regional Communications, Limited Partnership (Bell Aliant) for the sale of rights in a certain small number of Nortels IP Addresses, which sale closed on April 5, 2012. On May 7, 2012, the Canadian Court approved a further sale agreement Nortel and Vodafone Americas Inc. had entered into for the sale of rights in a small number of Nortels IP Addresses. The proceeds from the sale to Bell Aliant have been deposited into NNLs single purpose bank account, which has been included in non-current restricted cash, and upon the closing of the sale to Vodafone, such proceeds will also be deposited into the same account. Similar to the earlier sales described above, the financial and other terms of these two sale agreements, including the cash purchase price and the IP Addresses included in the sales, were sealed by order of the Canadian Court for the reasons set out above. Nortel continues to seek buyers for the remainder of its IP Addresses. Other Developments Under the CCAA Proceedings, the Canadian Debtors filed a motion for an order authorizing and directing the Canadian Debtors to cease performing any remediation at or in relation to five sites (Belleville, Brampton, Brockville, Kingston and London, Ontario), and that any claims in relation to such remediation be subject to the court approved claims process under the CCAA Proceedings. Nortel brought the motion to disclaim any further obligation for such properties that are no longer owned or used by Nortel and that Nortel and its creditors derive no benefit from any further remediation. Subsequent to the filing of the motion, NNL entered into a transition agreement regarding the Brampton site that facilitated a gradual cessation of Nortels environmental risk related tasks at that site, which tasks have now been completed. The Ministry of the Environment (the MOE) made remediation orders with respect to the four other sites. The motion was heard in September 2011 in the Canadian Court, wherein the Canadian Debtors sought advice and direction that the MOE remediation orders were in breach of the CCAA stay. The MOE did not seek to enforce the remediation orders while the Canadian Courts decision was outstanding and Nortel continued to undertake environmental risk assessments and remediation related tasks at those sites. On March 9, 2012, the Canadian Court issued an order granting the Canadian Debtors motion, in particular agreeing that the MOE remediation orders are stayed under the CCAA Proceedings and authorizing Nortel to cease performing any remediation activities at or in relation to the five sites, and releasing Nortel from all contractual obligations to carry out remediation requirements at such sites. The order further stipulates that any claims in relation to any current or future remediation requirements by the MOE against Nortel or its current or former directors or officers are subject to resolution and determination in accordance with the claims procedure and claims resolution orders approved by the Canadian Court on July 30, 2009 and September 16, 2010, respectively. On March 23, 2012, Her Majesty the Queen in right of Ontario as represented by the MOE served a notice of motion for leave to appeal the March 9, 2012 Canadian Court order. Nortel has given notice that, pursuant to the order, it is ceasing continued remediation activities. Condensed Combined Debtors Financial Statements The financial statements contained within this note have been prepared in accordance with the guidance of ASC 852 and represent the condensed combined financial statements of the Canadian Debtors (Debtors financial statements) that are included in the unaudited condensed consolidated financial statements for the three months ended March 31, 2012 and 2011. The condensed combined statements of operations exclude the Canadian Debtors interests in the results of operations of non-Debtor subsidiaries. Intercompany Transactions Intercompany transactions and balances with Nortels non-Debtor subsidiaries and affiliates have not been eliminated in the Debtors financial statements. Contractual Interest Expense on Outstanding Long-Term Debt During the three months ended March 31, 2012, Nortel has continued to accrue for interest expense of $87 ($79 for the three months ended March 31, 2011) in its normal course of operations related to debt issued by NNC and NNL in Canada until it obtains a claims determination order that adjudicates the claims. During the pendency of the Creditor Protection Proceedings Nortel generally has not made and does not expect to make payments to satisfy any of the interest obligations of the Debtors. Nortel has continued to accrue interest on the $1,000 floating rate notes that matured on July 15, 2011 until it obtains a claims determination order that adjudicates the claim. Foreign Currency Denominated Liabilities ASC 852 requires pre-petition liabilities of the Canadian Debtors 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. For foreign currency denominated liabilities, the CCAA requires allowable claims to be translated at the exchange rate in effect as of the Petition Date unless otherwise provided for in a court-approved plan. The claims process approved by the Canadian Court provides that foreign currency denominated claims must be calculated by the Canadian Monitor in Canadian dollars using a January 13, 2009 exchange rate. However, the claims process order
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Table of Contentsspecifically recognizes the ability of the Canadian Debtors to utilize a different exchange rate in any proposed plan. Therefore, given the impact that fixing exchange rates may have on the amounts ultimately settled, in Canada, foreign currency denominated balances, including Nortels U.S. dollar denominated debt, will not be accounted for using the Petition Date exchange rate but rather will continue to be accounted for in accordance with FASB ASC 830 Foreign Currency Matters (ASC 830). To date, the Canadian Debtors have not developed any plan or proposed an alternative exchange rate and any plan would be subject to creditor approval prior to the Canadian Courts approval. Cash Restrictions As a result of the Creditor Protection Proceedings, cash and cash equivalents are generally available to fund operations in particular jurisdictions, but generally are not available to be freely transferred between jurisdictions, regions, or outside joint ventures, other than for normal course post - Petition Date intercompany trade and pursuant to specific agreements approved by the Canadian Court. Proceeds from the various business and asset divestitures, as discussed above, are being held in escrow until the applicable jurisdictions can determine the proceeds allocations and are not available to fund operations.
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Notes to Condensed Consolidated Financial Statements (unaudited) (Continued) CONDENSED COMBINED STATEMENTS OF OPERATIONS (Millions of U.S. Dollars)
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Notes to Condensed Consolidated Financial Statements (unaudited) (Continued) CONDENSED COMBINED BALANCE SHEETS (Millions of U.S. Dollars)
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Table of ContentsNORTEL NETWORKS CORPORATION (Under Creditor Protection Proceedings as of January 14, 2009 note 2) Notes to Condensed Consolidated Financial Statements (unaudited) (Continued) CONDENSED COMBINED STATEMENTS OF CASH FLOWS (Millions of U.S. Dollars)
3. Accounting changes (a) Presentation of Comprehensive Income In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income (ASU 2011-5), effective for interim periods and years beginning after December 15, 2011. The issuance of ASU 2011-5 is intended to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The guidance in ASU 2011-5 supersedes the presentation options in ASC Topic 220 and facilitates convergence of U.S. GAAP and International Financial Reporting Standards by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders equity and requiring that all non-owner changes in stockholders equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB issued an ASU to indefinitely defer the effective date of the provision pertaining only to the presentation of reclassification adjustments out of accumulated other OCI and reinstated the previous requirements to present reclassification adjustments either on the face of the statement in which OCI is reported or to disclose them in a note to the financial statements. Amendments to comprehensive income should be applied retrospectively and become effective for public entities for interim and annual periods beginning after December 15, 2011 with early adoption permitted. Nortel has historically disclosed comprehensive income in a separate note in its condensed consolidated financial statements, therefore the adoption of ASU 2011-05 has resulted in the inclusion of a separate statement in financial statements, directly after condensed consolidated balance sheet, rather than in the notes to the financial statements.
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Table of Contents4. Reorganization Items net Reorganization items represent the net direct and incremental charges related to the Creditor Protection Proceedings such as revenues, expenses including professional fees directly related to the Creditor Protection Proceedings, realized gains and losses, and provisions for losses resulting from the reorganization and restructuring of the business. Reorganization items for the three months ended March 31, 2012 and 2011 consisted of the following:
Nortel received $58 relating to reorganization items - net in the three months ended March 31, 2012, attributable to $77 received from various divestitures and $4 for interest income, partially offset by $10 paid for professional fees and $13 paid for employee incentive plans. Nortel received $21 relating to reorganization items in the three months ended March 31, 2011, attributable to $49 received for various divestitures and $3 for interest income, partially offset by $16 paid for professional fees, and $15 paid for employee incentive plans. See the unaudited condensed consolidated statements of cash flows for the non-cash portion of reorganization items. 5. Condensed consolidated financial statement details The following tables provide details of selected items presented in the unaudited condensed consolidated statements of operations and cash flows for the three months ended March 31, 2012 and 2011, and the unaudited condensed consolidated balance sheets as of March 31, 2012 and December 31, 2011. Condensed consolidated statements of operations Other operating income net:
Other expense net:
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Table of ContentsCondensed consolidated balance sheets Accounts receivable net:
Other current assets:
Plant and equipment net:
Other assets:
Other accrued liabilities:
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Table of ContentsOther liabilities:
Condensed consolidated statements of cash flows Change in operating assets and liabilities net:
Taxes and reorganization items paid (received):
6. 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 under such plans, and will be classified in cost of revenues, SG&A, and R&D as applicable. Nortels 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. During the three months ended March 31, 2012 and 2011, charges related to Nortels pre-Petition Date cost reduction plans were minimal. As of March 31, 2012, the pre-petition cost reduction provision of $34 represents $23 in accrued severance claims for former employees and $11 in contract settlement and lease costs. As of December 31, 2011, the pre-petition cost reduction provision was $34. 7. Post-Petition Date cost reduction activities In connection with the Creditor Protection Proceedings, Nortel has implemented certain workforce and other cost reduction activities and will continue such activities during this process. The actions related to these activities are expected to occur as they are identified. The current estimated total charges to earnings and cash outlays are subject to change as a result of Nortels 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.
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Table of ContentsWorkforce Reduction Activities Three months ended March 31, 2012 For the three months ended March 31, 2012, approximately $4 of the total charges relating to the net workforce reduction of 51 positions were incurred. As Nortel continues to progress through the Creditor Protection Proceedings, Nortel expects to incur charges and cash outlays related to workforce and other cost reduction strategies. Nortel will continue to report future charges and cash outlays under the broader strategy of the post petition cost reduction plan. Three months ended March 31, 2011 For the three months ended March 31, 2011, approximately $4 of the total charges relating to the net workforce reduction of 86 positions were incurred as of March 31, 2011, which substantially completes the workforce and other cost reduction strategies discussed above. During the three months ended March 31, 2012, changes to the workforce provision balances were as follows:
Other Cost Reduction Activities During the three months ended March 31, 2012 and 2011, there were no charges related to Nortels real estate cost reduction activities. As of March 31, 2012, Nortels real estate and other cost reduction balances were approximately $7, which are classified as subject to compromise. As of December 31, 2011, Nortels real estate and other cost reduction balances were approximately $6, which are classified as subject to compromise. 8. Income taxes During the three months ended March 31, 2012, Nortel recorded a tax expense of $5 on loss from operations before income taxes of $54. The tax expense of $5 is comprised of $4 resulting from taxes on earnings in Asia, $1 of other taxes including withholding taxes, and $1 resulting from a provision for actual tax adjustments to the prior year balances, partially offset by decreases in uncertain tax positions of $1. The ultimate determination of the final allocation of proceeds among the various Nortel legal entities has not yet occurred and may be materially different from the classification and related amounts shown in these unaudited condensed consolidated financial statements. Nortel expects that the final allocation of proceeds will mainly result in adjustments to existing loss carry-forward balances or other tax attributes, which will be offset with valuation allowance and have a nil impact to taxes payable. During the three months ended March 31, 2011, Nortel recorded a tax recovery of $1 on loss from operations before income taxes of $103. The tax recovery of $1 is comprised of a net tax recovery relating to prior years of $2 and is partially offset by other taxes of $1. As of March 31, 2012, Nortels net deferred tax liabilities were $8, representing the accrual of deferred tax liabilities associated with the expected withholding taxes relating to investments in CALA and Asia. There is significant uncertainty concerning the forecasted income or loss for 2012 and beyond and the uncertainty concerning the estimated final proceeds allocation by jurisdiction, and thus this significant negative evidence outweighs any positive evidence that may exist. Therefore, Nortel has concluded that a full valuation allowance continues to be necessary against Nortels deferred tax assets in all jurisdictions as of March 31, 2012. Nortel had approximately $1,522 and $1,487 of total gross unrecognized tax benefits as of March 31, 2012 and December 31, 2011, respectively. Of the total gross unrecognized tax benefits of $1,522, $10 represented the amount of unrecognized tax benefits, net of valuation allowance that would favorably affect the effective income tax rate in future periods, if recognized. The net increase of $35 since December 31, 2011 resulted from $36 due to changes to foreign exchange rates, offset by a decrease in a prior year uncertain position of $1. Nortel recognized interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the three months ended March 31, 2012, Nortel recovered $1 related to interest, penalties and foreign exchange losses. Nortel has accrued approximately $6 and $7 for the payment of interest and penalties as of March 31, 2012 and December 31, 2011, respectively.
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Table of ContentsNortel believes it is reasonably possible that $1,417 of its gross unrecognized tax benefit will decrease, of which $655 relates to the deductibility of legal settlement expenses and $761 relates to investment tax credits with the resulting impact being the expiry of unutilized non capital losses from prior years. 9. Employee benefit plans Plan Description Nortel maintains various investment plans covering substantially all of its employees, and acts as the plan sponsor for its defined benefit and defined contribution plans. Below is a list of relevant plans discussed in this note and their status as of March 31, 2012 and the basis for which they are being accounted for as of March 31, 2012. Note that although these plans represent Nortels major retirement plans, Nortel also has smaller pension plan arrangements in other countries.
Wind-up Order of the Canadian Funded Pension Plans On March 8, 2011, the Ontario Superintendent of Financial Services ordered the wind-up of the Canadian Pension Plans with an effective date of October 1, 2010. Nortels net pension liability for the Canadian Pension Plans is based on the pension assets and liabilities as of this wind-up date. As such, the 2012 and 2011 pension expense for the Canadian Pension Plans was limited to the amortization of accumulated other comprehensive income. As a result of this order, Nortel remeasured the pension obligations under the plans in the first quarter of 2011 using wind-up assumptions as of the effective date, resulting in a reduction to pension liabilities and OCI of $96. The settlement process for the Canadian Pension Plans has not been finalized, and as such the assumptions used to calculate the Canadian Pension Plans pension obligations could be subject to change. There were no advancements in the settlement process for the Canadian Pension Plans during the three months ended March 31, 2012, which would require an adjustment to the carrying amount of the liability. Pension Benefits The following details the net pension expense for the defined benefit plans for the following periods:
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Table of Contents10. Guarantees Nortels 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 partys failure to perform under a specified agreement. The following table provides a summary of Nortels guarantees as of March 31, 2012:
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11. Fair Value ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820, 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 ASC 820 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 Nortels 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.
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Table of ContentsDetermination of fair value When available, Nortel uses quoted market prices to determine fair value of items classified in Level 1 of the fair value hierarchy, more specifically Nortels long-term debt including amounts subject to compromise. 12. Commitments Bid, performance-related and other bonds Nortel has entered into bid, performance-related and other bonds associated with various contracts. Other bonds primarily relate to warranty 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 up to one year. Any potential payments which might become due under these bonds would be related to Nortels 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, 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:
13. 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 loss per common share for the following periods:
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Table of Contents14. Shareholders deficit The following are the changes in shareholders deficit during the three months ended March 31, 2012:
15. Liabilities subject to compromise As a result of the Creditor Protection Proceedings, pre-petition liabilities may be subject to compromise or may otherwise be affected by a court-approved plan 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 Nortels cash management system, satisfaction of customer obligations, payments to suppliers for goods and services received after the Petition Date and retention of professionals. The Debtors have been paying and intend to continue to pay undisputed post-petition claims in the ordinary course of business. Under the Creditor Protection Proceedings, the Debtors have certain rights, which vary by jurisdiction, to reject, repudiate or no longer continue to perform various types of contracts or arrangements. Damages resulting from rejecting, repudiating or no longer continuing to perform a contract or arrangement are treated as general unsecured claims and will be classified as liabilities subject to compromise. ASC 852 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. Liabilities subject to compromise consist of the following:
As of March 31, 2012, the Canadian Debtors have received approximately 1,057 claims asserting approximately $29,526 (calculated utilizing exchange rates as of the petition date for presentation purposes) in aggregate outstanding liquidated claims. Some of these claims are unliquidated and are therefore not reflected in the aggregate claim amount above. The Canadian Debtors continue to investigate differences between the claim amounts filed by creditors and claim amounts determined by the Canadian Debtors. Certain claims filed may be duplicative (particularly given the multiple jurisdictions and Canadian Debtors involved in the Creditor Protection Proceedings), based on contingencies that have not occurred, or may be otherwise overstated, and would therefore be
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Table of Contentssubject to revision or disallowance. Nortel believes the variance between total claims and total liabilities subject to compromise is primarily related to duplicative claims. The determination of Nortels liabilities subject to compromise considers these factors, and these liabilities are subject to change as a result of the ongoing investigation by the Canadian Debtors of filed proofs of claim. A number of proofs of claim, for which Nortel has not accrued any amount or accrued significantly less than the amounts in the proofs of claim, continue to be reviewed by the Canadian Debtors and may result in significant changes in future periods once these reviews are complete. An additional approximate 16,000 claims related to the employee compensation claims process totaling CAD$1.06 billion have been received by the Canadian Debtors. As of March 31, 2012, the Canadian Debtors have resolved 669 claims, reducing the aggregate amount claimed against the Canadian Debtors by approximately $7,129. Although the Canadian Court has established a bar date, subject to certain excluded claims, by which certain proofs of claim against the relevant Canadian Debtors were required to be filed if the claimants were to receive any distribution under the Creditor Protection Proceedings, certain further claims may be permitted. In addition, the Canadian Debtors anticipate that additional proofs of claim will be the subject of future objections as such proofs of claim are reconciled. Accordingly, the ultimate number and amount of allowed claims is not determinable at this time. 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. In addition, a number of proofs of claim, for which Nortel has not accrued any amount or accrued significantly less than the amounts in the proofs of claim, continue to be reviewed by the Canadian Debtors and may result in significant changes in future periods once these reviews are complete. Classification for purposes of these financial statements of any pre-petition liabilities on any basis other than liabilities subject to compromise is not an admission of fact or legal conclusion by Nortel as to the manner of classification, treatment, allowance, or payment in the Creditor Protection Proceedings, including in connection with any plan that may be approved by any relevant court and that may become effective pursuant to a courts order. 16. Contingencies Creditor Protection Proceedings On January 14, 2009, the Canadian Debtors obtained an order from the Canadian Court for creditor protection and commenced ancillary proceedings under Chapter 15 of the U.S. Bankruptcy Code, the U.S. Debtors filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code, and each of the EMEA Debtors obtained an administration order from the English Court. After the Petition Date, the Israeli Debtors initiated similar proceedings in Israel. One of Nortels French subsidiaries, NNSA, was placed into secondary proceedings in France and NNCI filed a voluntary petition for relief under Chapter 11 in the U.S. Court and became a party to the Chapter 11 Proceedings. Generally, as a result, all actions to enforce or otherwise effect payment or repayment of liabilities of any Debtor arising prior to the Petition Date, and substantially all pending claims and litigation against any Debtor, are stayed as of the Petition Date. Absent further order of the applicable courts and subject to certain exceptions and, in Canada, potential time limits, no party may take any action to recover on pre-petition claims against any Debtor. The Pensions Regulator Financial Support Directions According to various claims filed by the trustee of the U.K. defined benefit pension plan and the PPF against certain Debtors, the U.K. defined benefit pension plan had a purported deficit estimated (on a buy-out basis) of £2,100 or $3,300 as at January 2009. In January 2010, the Pensions Regulator, purporting to act under the Pensions Act 2004 (U.K.) (U.K. Statute) issued a warning notice (Warning Notice) to certain Nortel entities, including, among others, the Canadian Debtors and the U.S. Debtors. The Pensions Regulator is a statutory agency charged with responsibility for regulating the operations and administration of occupational pension schemes in the U.K., such as the U.K. defined benefit pension plan. The Warning Notice is the first step in a process set forth under the U.K. Statute to enable the Pensions Regulator to issue a financial support direction (FSD) under the U.K. Statute directing affiliates of NNUK to provide financial support to eliminate the purported deficit. If a company to which a FSD is issued fails to comply with it, the Pensions Regulator may issue a contribution notice (Contribution Notice) to any one or more persons to whom the FSD was addressed stating that the person is liable to pay to the trustees of the pension scheme the sum specified in the Contribution Notice, where the Pensions Regulator considers it reasonable to impose the liability on the person to pay the specified sum. The sum specified may be the whole or a portion of the actual or estimated deficit of the pension scheme. In the Warning Notice, the Pensions Regulator identified certain Nortel entities, including, among others, NNC, NNL, NNI and NNCI, as targets of a procedure before the determinations panel of the Pensions Regulator (Determinations Panel) to determine whether to issue a FSD (U.K. Pension Proceeding). On February 26, 2010, the Canadian Debtors obtained an order of the Canadian Court, which included, among other things, (i) a declaration that the purported commencement of proceedings and exercise of rights by the Pensions Regulator breaches the Initial Order; and (ii) a declaration that any result obtained in the U.K. in breach of the stay under the CCAA Proceedings would not be recognized in the Canadian claims process. Also on February 26, 2010, the U.S. Debtors obtained an order of the U.S. Court enforcing the automatic stay under the U.S. Bankruptcy Code against the trustee of the U.K. defined benefit pension
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Table of Contentsplan (U.K. Pension Trustee) and the PPF, which is fully applicable to the U.K. Pension Trustees and PPFs participation against the U.S. Debtors in the U.K. Pension Proceeding. In addition, the order of the U.S. Court provided that with respect to the U.S. Debtors, such proceedings are deemed void and without force or effect. The Pensions Regulator appealed the decision of the Canadian Court which appeal was heard and dismissed on June 16, 2010, by the Ontario Court of Appeal. The Pensions Regulator submitted an application for leave to appeal the decision of the Ontario Court of Appeal to the Supreme Court of Canada, which application was dismissed on January 27, 2011. In addition, the U.K. Pension Trustee brought a motion before the Canadian Court to have the stay lifted, to allow the U.K. Pension Proceeding to go forward as a permitted proceeding, which motion was initially set for hearing on May 31, 2010, but was subsequently adjourned without date on the consent of all interested parties. The U.K. Pension Trustee and the PPF also appealed the decision of the U.S. Court enforcing the stay. That appeal was denied by the U.S. Court of Appeals for the Third Circuit (U.S. Appeals Court) on December 29, 2011 and on January 24, 2012 the U.S. Appeals Court denied a petition by the U.K. Pension Trustee and the PPF for a rehearing of the appeal. On April 20, 2012, the U.K. Pension Trustee and the PPF filed a petition for certiorari with the Supreme Court of the United States, requesting review of the U.S. Appeals Courts December 29, 2011 decision. Notwithstanding the orders of the Canadian Court and the U.S. Court and the dismissal of the Pension Regulators appeal by the Ontario Court of Appeal, the FSD proceedings commenced in the U.K. on June 2, 2010, and on June 25, 2010, the Determinations Panel issued a determination notice (Determination Notice) indicating that a FSD would be issued against certain Debtors including, among others, NNC, NNL, NNI and NNCI. On April 1, 2011, the Determinations Panel issued FSDs to NNC, NNL, NNI and NNCI requiring each of them to secure that financial support be put in place for the U.K. defined benefit pension plan within six calendar months of the date of the FSDs. The other Debtors that received the Determination Notice have exercised their right under the U.K. Statute to refer the Determinations Panels determination to the Pensions Regulator Tribunal established under the U.K. Statute for a further determination of the matter. Nortel is of the view that the Determination Notice and the FSD issued to NNC, NNL, NNI and NNCI are null and void given the court decisions noted above. In September 2010, the U.K. Administrators applied to the English Court for directions concerning the application and effect of the FSD regime contained in the U.K. Statute upon those EMEA Debtors that were identified in the Warning Notice. On December 10, 2010, the English Court ruled that the Pensions Regulator could pursue FSDs and Contribution Notices against the target Debtors in accordance with the provisions of the U.K. Statute. Further, the English Court held that the debt created by any Contribution Notice that may be issued constitutes an administration or liquidation expense of an insolvent target company, rather than a provable debt in the insolvency proceedings, thereby giving it super priority status over the claims of other creditors of the insolvent target company. The U.K. Administrators appealed this decision to the Court of Appeal of England and Wales (U.K. Appeal Court) and, on October 14, 2011, the U.K. Appeal Court upheld the English Courts decision. The U.K. Administrators have been granted leave to appeal the U.K. Appeal Courts decision to the Supreme Court. Nortel is of the view that these court decisions in the U.K. have no authoritative application in the CCAA Proceedings or the Chapter 11 Proceedings and that the validity and relative priority of claims filed in those proceedings are matters to be determined by the Canadian Court and the U.S. Court, as applicable. Pursuant to an intercompany guarantee agreement relating to the U.K. defined benefit pension plan, NNL has guaranteed certain payment obligations of NNUK under a Funding Agreement executed on November 21, 2006. Pursuant to a further intercompany guarantee agreement, NNL has guaranteed NNUKs payment obligations arising upon the wind up, dissolution or liquidation and consequent windup of such plan to the lesser of (a) $150 and (b) the amount of the plans buyout deficit. See note 10. Securities Class Action Claim against former CEO and former CFO On May 18, 2009, a complaint was filed in the U.S. District Court for the Southern District of New York alleging violations of federal securities law between the period of May 2, 2008 through September 17, 2008, against Mike Zafirovski (Nortels former President and Chief Executive Officer) and Pavi Binning (Nortels former Executive Vice President, Chief Financial Officer and Chief Restructuring Officer). Although Nortel is not a named defendant, this lawsuit has been stayed as a result of the Creditor Protection Proceedings. Messrs Zafirovski and Binning have filed claims in the U.S. Court for indemnification and contribution for potential liability arising out of this matter in amounts to be determined. As of November 8, 2010, the United States District Court for the Southern District of New York ordered that the matter be placed on the suspense docket pending developments in the Creditor Protection Proceedings. ERISA Lawsuit As previously reported, beginning in December 2001, NNC, NNL and NNI, together with certain of its then-current and former directors, officers and employees, were named as defendants in several purported class action lawsuits pursuant to ERISA. These lawsuits were consolidated into a single proceeding in the U.S. District Court for the Middle District of Tennessee (the U.S. District Court). This lawsuit is on behalf of participants and beneficiaries of the Nortel Networks Inc. Long-Term Investment Plan, who held shares of the Nortel Networks Stock Fund during the class period. The lawsuit alleged, 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. As a result of the Creditor Protection Proceedings, on September 25, 2009, the U.S. District Court ordered the case administratively closed. The parties to the action agreed to a final form of Stipulation of Settlement (the Stipulation) whereby the defendants will cause their underwriter, Chubb Insurance Company of Canada (Chubb), to pay $21.5 into an escrow account on behalf of the defendants as full and final settlement of the action and in consideration for the releases and discharges provided under the Stipulation. Such settlement amount will be distributed in accordance with the terms of the
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Table of ContentsStipulation. In a side agreement, NNC, NNL, NNI and Chubb stipulated that existing claims filed by Chubb in the Creditor Protection Proceedings in Canada and in the U.S. will be reduced and allowed as general unsecured claims upon deposit by Chubb of the final settlement payments. The Stipulation and the side agreement were approved by the Canadian Court and the U.S. Court. The U.S. District Court also granted preliminary approval of the Stipulation. A fairness hearing for final approval was held on January 11, 2012 and the Stipulation was approved. Nortel has recorded a provision to reflect its best estimate of an allowed claim amount. 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 Nortels 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. As a result of the Creditor Protection Proceedings, this lawsuit has been stayed. Nortel Statement of Claim Against its Former Officers In January 2005, NNC and NNL filed a Statement of Claim in the Ontario Superior Court of Justice against Messrs. Frank Dunn, Douglas Beatty and Michael Gollogly, Nortels former senior officers who were terminated for cause in April 2004, seeking the return of payments made to them under Nortels bonus plan in 2003. One-half of any recovery from this litigation is subject to the Global Class Action Settlement. See note 10. Former Officers Statements of Claim Against Nortel In April 2006, Mr. Dunn filed a Notice of Action and Statement of Claim in the Ontario Superior Court of Justice against NNC 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. As a result of the Creditor Protection Proceedings, these lawsuits have been stayed. Environmental matters 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, 2012, accruals for environmental matters were $8 and have been recorded in liabilities subject to compromise. At December 31, 2011, Nortel had remedial activities under way at five sites that are either currently or previously owned. On March 19, 2012, the Canadian Court issued an order that, among other things, authorized Nortel to cease performing any remediation activities at or in relation to the five sites. See note 2 for further information on this order. 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 individual or aggregate amount of monetary liability or financial impact to Nortel of the above matters, which, unless otherwise specified, seek damages from the defendants of material or indeterminate amounts or could result in fines and penalties. Except as noted above, 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 as otherwise described herein, Nortel intends to defend the above actions, suits, claims and proceedings in which it is a defendant, litigating or settling cases where in managements judgment it would be in the best interest of stakeholders 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.
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Table of Contents17. Subsequent events In addition to the events identified in note 2, the Company has evaluated subsequent events through the filing date and determined that no other significant events occurred which require disclosure.
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The following Managements Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Nortel Networks Corporation. As noted herein, we have completed the divestitures of all of our businesses as part of our Creditor Protection Proceedings. The MD&A should be read in combination with our unaudited condensed consolidated financial statements and the accompanying notes. All monetary amounts in this MD&A are in millions and in United States (U.S.) Dollars except per share amounts or unless otherwise stated. Certain statements in this MD&A contain words such as could, expect, may, anticipate, believe, intend, estimate, plan, envision, seek and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections which we believe are reasonable but which are subject to important assumptions, risks and uncertainties and may prove to be inaccurate. Consequently, our actual results could differ materially from our expectations set out in this MD&A. In particular, see the Risk Factors section of this report as well as in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the U.S. Securities and Exchange Commission (SEC) and Canadian securities regulatory authorities (2011 Annual Report) for factors that could cause actual results or events to differ materially from those contemplated in forward-looking statements. Unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Where we say we, us, our, Nortel or the Company, we mean Nortel Networks Corporation or Nortel Networks Corporation and its subsidiaries that continue to be consolidated, as applicable. Where we say NNC, we mean Nortel Networks Corporation.
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Table of ContentsCreditor Protection Proceedings On January 14, 2009 (Petition Date), after extensive consideration of all other alternatives, with the unanimous authorization of our board of directors after thorough consultation with our advisors, we initiated creditor protection proceedings in multiple jurisdictions under the respective restructuring regimes of Canada, under the Companies Creditors Arrangement Act (CCAA) (CCAA Proceedings), the United States (U.S.) under Chapter 11 of the U.S. Bankruptcy Code (Chapter 11) (Chapter 11 Proceedings), the United Kingdom (U.K.) under the Insolvency Act 1986 (U.K. Administration Proceedings), and subsequently, Israel under the Israeli Companies Law 1999 (Israeli Administration Proceedings). On May 28, 2009, one of our French subsidiaries, Nortel Networks SA (NNSA) was placed into secondary proceedings (French Secondary Proceedings). The CCAA Proceedings, Chapter 11 Proceedings, U.K. Administration Proceedings, Israeli Administration Proceedings and French Secondary Proceedings are together referred to as the Creditor Protection Proceedings. On July 14, 2009, Nortel Networks (CALA) Inc. (NNCI), a U.S. based subsidiary with operations in the Caribbean and Latin America (CALA) region, also filed a voluntary petition for relief under Chapter 11 in the U.S. Bankruptcy Court for the District of Delaware (U.S. Court) and became a party to the Chapter 11 Proceedings. We initiated the Creditor Protection Proceedings with a consolidated cash balance, as of December 31, 2008, of approximately $2,400, in order to preserve our liquidity and fund operations during the process. As used herein: Bondholder Group means a group purporting to hold a portion of our publicly traded debt; Canadian Monitor means Ernst & Young Inc. as court-appointed monitor in the CCAA Proceedings;Debtors means: (i) us, together with our principal operating subsidiary Nortel Networks Limited (NNL) and certain other Canadian subsidiaries (collectively, Canadian Debtors) that filed for creditor protection pursuant to the provisions of the CCAA in the Ontario Superior Court of Justice (Canadian Court); (ii) Nortel Networks Inc. (NNI), Nortel Networks Capital Corporation (NNCI) and certain other U.S. subsidiaries (collectively, U.S. Debtors) that have filed voluntary petitions under Chapter 11 in the U.S. Court; (iii) certain Europe, Middle East and Africa (EMEA) subsidiaries that made consequential filings under the Insolvency Act 1986 in the High Court of England and Wales (English Court) (including NNSA) and certain Israeli subsidiaries (collectively, Israeli Debtors) that made consequential filings under the Israeli Companies Law 1999 in the District Court of Tel Aviv (collectively, EMEA Debtors). French Liquidator means the liquidator appointed by the Versailles Commercial Court in secondary insolvency proceedings commenced by Nortel Networks SA in France; U.K. Administrators means, correctively, a representative of Ernst & Young LLP (in the U.K.) and a representative of Ernst & Young Chartered Accountants (in Ireland) as court-appointed joint administrators of Nortel Networks (Ireland) Ltd. (NNIL) and representatives of Ernst & Young LLP (in the U.K.) as court-appointed joint administrators of the EMEA Debtors other than NNIL; U.S. Creditors Committee means the Official Committee of Unsecured Creditors of the U.S. Debtors appointed in the Chapter 11 Proceedings; U.S. Principal Officer means the principal officer of the U.S. Debtors appointed in the Chapter 11 Proceedings; and U.S. Trustee means the United States Trustee for the District of Delaware. For further information regarding prior developments in connection with the Creditor Protection Proceedings, refer to our 2011 Annual Report. Significant Business Divestitures In June, 2009, we determined that selling our businesses was the best path forward. We have completed divestitures of all of our businesses including: (i) the sale of substantially all of our Code Division Multiple Access (CDMA) business and Long Term Evolution (LTE) Access assets to Telefonaktiebolaget LM Ericsson (Ericsson); (ii) the sale of substantially all of the assets of our Enterprise Solutions (ES) business globally, including the shares of Nortel Government Solutions Incorporated (NGS) and DiamondWare, Ltd. (Diamondware), to Avaya Inc. (Avaya); (iii) the sale of the assets of our Wireless Networks (WN) business associated with the development of Next Generation Packet Core network components (Packet Core Assets) to Hitachi, Ltd. (Hitachi); (iv) the sale of certain portions of our Layer 4-7 data portfolio to Radware Ltd.; (v) the sale of substantially all of the assets of our Optical Networking and Carrier Ethernet businesses to Ciena Corporation (Ciena); (vi) the sale of substantially all of the assets of our Global System for Mobile communications (GSM)/GSM for Railways (GSM-R) business to Ericsson and Kapsch CarrierCom AG (Kapsch); (vii) the sale of substantially all of the assets of our Carrier VoIP and Application Solutions (CVAS) business to GENBAND Inc. (now known as GENBAND U.S. LLC (GENBAND)); (viii) the sale of NNLs 50% plus one share interest in LG-Nortel Co. Ltd. (LGN), our Korean joint venture with LG-Electronics, Inc. (LGE), to Ericsson; (ix) the sale of substantially all of the assets of our global Multi Service Switch (MSS) business to Ericsson; (x) the sale of substantially all of the assets of Guangdong-Nortel Telecommunications Equipment Co. Ltd. (GDNT) to Ericsson Mobile Data Applications Technology Research and Development Guangzhou Company Limited and Ericsson (Guangdong Shunde) Communications Company Limited (collectively, Ericsson China); (xi) the sale of our remaining patents and patent applications to a consortium consisting of Apple Inc., EMC Corporation, Ericsson, Microsoft Corporation, Research in Motion Limited and Sony Corporation (collectively, the Consortium); and (xii) the sale of a small number of our Internet Protocol version 4 addresses to various purchasers. One of the key remaining matters under the Creditor Protection Proceedings is the determination of allocation of sale proceeds among the various Nortel legal entities that participated in the sales of our businesses, which include entities subject to the respective Creditor Protection Proceedings in the different jurisdictions as well as entities that are not subject to any court supervision or proceedings.
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Table of ContentsDivestiture Proceeds Received As of March 31, 2012, approximately $7,800 in net proceeds have been generated and received through the completed sales of businesses and remaining patents and patent applications. These divestiture proceeds include the following approximate amounts:
As of March 31, 2012, $7,320 of proceeds received from divestitures of businesses and remaining patents and patent applications is being held in escrow and an additional $229, representative of proceeds from the sale of LGN, is included in non-current restricted cash and cash equivalents, all of which is currently reported in NNL solely for financial reporting purposes (including with respect to any gain recorded on such divestitures). The difference between the net proceeds received and the amount in escrow at March 31, 2012 is as a result of amounts that, from time to time, have been distributed with the consent of each of the Debtors estates and court approvals, as applicable, from the escrow accounts to satisfy: 1) various obligations arising from the divestitures, whether through payments to third party vendors, or to reimburse the Debtors or non-consolidated subsidiaries for costs incurred, or 2) payments to the Debtors or non-consolidated subsidiaries related to settlements reached in respect of certain agreements involving proceeds allocation. The ultimate determination of the final allocation of such proceeds among the various Nortel legal entities, including entities that are not consolidated in the accompanying unaudited condensed consolidated financial statements, has not yet occurred and may be materially different from the NNL classification and related amounts shown in these financial statements. The Interim Funding and Settlement Agreement (IFSA) and the escrow agreements for sales divestiture proceeds entered into by NNL, NNI and other Nortel legal entities provide for the processes for determining the final allocation of divestiture proceeds among such entities, either through joint agreement or, failing such agreement, other dispute resolution proceedings. Adjustments to the NNL classification and any related amounts arising from the ultimate allocation will be recognized when finalized. The NNL classification and related amounts shown in the accompanying unaudited condensed consolidated financial statements are not determinative of, and have not been accepted by any debtor estate, any party in interest in the Creditor Protection Proceedings or any court overseeing such proceedings, for purposes of deciding the final allocation of divestiture proceeds. During the three months ended March 31, 2012, we received additional proceeds of $70 that had been held in escrow subject to the successful completion of performance obligations under the transition services agreements (TSAs) entered into in connection with the sale of substantially all of our CDMA business, LTE Access assets, and CVAS business, and our North American GSM business, all of which were recorded as gain on divestitures included in reorganization items net. As of March 31, 2012, a further $27 in connection with the divestitures of substantially all of the assets of our Optical Networking and Carrier Ethernet businesses, CVAS business, and substantially all of the assets of our MSS business is currently unrecorded and will be recognized subject to agreement between Nortel and each of the various buyers that obligations under the TSAs have been completed. Such amounts, when and if received, will also be held in escrow until the final allocation of these proceeds as between various Nortel legal entities, including the U.S. and EMEA subsidiaries, is ultimately determined. Allocation of Divestiture Proceeds and Other Inter-Estate Matters At various times during the second half of 2009 and the first quarter of 2010, the Canadian Debtors, the U.S. Debtors and the U.K. Administrators, with the involvement of the Canadian Monitor, the U.S. Principal Officer, the U.S. Creditors Committee and the Bondholder Group engaged in negotiations regarding the scope and terms of a proposed protocol for resolving disputes concerning the allocation of sale proceeds (Allocation Protocol), as required by the terms of the IFSA. However, it became apparent that the parties
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Table of Contentshad differing views concerning the allocation of the sale proceeds, inter-company claims and the scope of the Allocation Protocol. In order to address this impasse, the Canadian Debtors, the U.S. Debtors and the U.K. Administrators agreed to temporarily suspend negotiations on the Allocation Protocol and instead focused on a process to facilitate a comprehensive settlement to resolve all material outstanding inter-estate matters, including the allocation of the sale proceeds and the settlement of inter-company claims. To this end, the parties met on several occasions to outline, on a confidential and without prejudice basis, their respective allocation methodologies and potential inter-company claims that may be asserted. As a result of these meetings and the complexity of the issues that were raised, the Canadian Debtors, the U.S. Debtors, the EMEA Debtors, the U.K. Administrators, the Canadian Monitor the U.S. Principal Officer, the U.S. Creditors Committee, the Bondholder Group and certain other interested parties (collectively, the Mediation Parties) agreed that these inter-estate negotiations would be aided by the appointment of a neutral mediator to review and mediate the issues. The parties selected Layn R. Phillips, a former U.S. federal district court judge and experienced commercial mediator, to serve as mediator and review the positions and viewpoints of the various parties on allocation and unresolved inter-estate matters. A confidential, non-binding mediation was held in November 2010. The mediation session did not result in the resolution of the issues presented. As a result of the November 2010 mediation session, and positions taken in the CCAA Proceedings, it became apparent that the U.K. Administrators and certain other parties, who were also substantial creditors of the EMEA Debtors, were alleging a number of significant potential claims against the Canadian Debtors as well as the U.S. Debtors. These potential claims were integral to the allocation positions of these parties and included allegations of proprietary and trust-type claims. Consequently, the Canadian Monitor and the Canadian Debtors determined that, absent reaching a comprehensive settlement of allocation and inter-company claims issues, these specific claims needed to be resolved first. Accordingly, the Canadian Debtors obtained an order of the Canadian Court establishing a process for the calling of claims from EMEA creditors. Notwithstanding the commencement of this process, the Mediation Parties continued to engage in discussions regarding the resumption of mediation and another confidential, non-binding mediation was held in April 2011. On April 13, 2011, we announced that the mediation process that had been commenced in respect of the allocation of sale proceeds of our various business and asset divestitures and other inter-estate matters, including inter-company claims, had ended without resolution of the matters in dispute. In light of the unsuccessful conclusion of the mediation process, we announced that delays in the ultimate resolution of allocation and inter-company claims matters potentially could be significant, and that such delays would result in a corresponding significant delay in the timing of distributions to holders of validated claims of the various estates. On April 25, 2011, the U.S. Debtors and the U.S. Creditors Committee filed a joint motion for an order establishing an allocation protocol for the sale proceeds as between various Nortel legal entities (Original Protocol Motion), and for related relief. Subsequently, as a result of further discussions, the U.S. Debtors and the U.S. Creditors Committee together with the Canadian Debtors jointly filed an amended and restated version of the Original Protocol Motion and agreed to collectively seek an order establishing an allocation protocol before the Canadian Court and the U.S. Court. The proposed order would have had the U.S. Court and the Canadian Court establish procedures and an expedited schedule for the cross-border resolution by the U.S. Court and the Canadian Court on the allocation of proceeds from the sales of our businesses and from the sale of our patent portfolio. The motion was heard at a joint hearing of the U.S. Court and Canadian Court on June 7, 2011. On June 20, 2011, we announced that the Canadian Court and the U.S. Court had reserved their decisions on the motions heard by such courts on June 7, 2011, and directed us, NNL and the other Canadian Debtors, NNI and the other U.S. Debtors, the EMEA Debtors, as well as certain other parties, to participate in a joint mediation of the issues raised in the motions. The directions provided that the Canadian Court and the U.S. Court together would appoint a sole mediator by supplemental order and that the mediator would determine the time, date, place and protocol of the mediation. On June 17, 2011, and as supplemented on June 29, 2011, the Canadian Court and the U.S. Court appointed The Honourable Warren K. Winkler, Chief Justice of Ontario, as the sole mediator (the Mediator) for the mediation. The mediation was ordered because of both courts concern that the time required to prepare their decisions would also delay allocation proceedings and, therefore, distributions to creditors of the various Nortel estates. The Mediator has the authority, in consultation with the parties to the mediation, to determine the scope of the mediation, as he deems appropriate, including the issue of allocation of the sale proceeds of Nortels various businesses and patent portfolio, and global issues relating to allocation and claims. Participation in this mediation is mandatory. The mediation process will be terminated (i) by a declaration by the Mediator that a settlement has been reached (any such settlement would be subject to the approval of the Canadian Court and the U.S. Court, on notice to parties in interest), (ii) by a declaration by the Mediator that further efforts at mediation are no longer considered worthwhile, or (iii) for any other reason as determined by the Mediator. At the request of the U.S. Court, the commencement of the mediation was delayed pending the outcome of the October 14, 2011 hearing (discussed in more detail below). The Canadian Court approved a claims process with regard to the significant inter-company claims made by the EMEA Debtors against the Canadian Debtors, which process included a requirement that claims be filed by March 18, 2011. In response to this call for claims, representatives of the U.K. Administrators, on behalf of the EMEA Debtors, filed 84 proofs of claims against the Canadian Debtors and unspecified directors and officers of NNC and NNL (the EMEA Claims). The EMEA Claims contain broad ranging claims set out with limited specificity. The EMEA Claims also include a number of large priority claims, which if allowed, would significantly reduce the potential proceeds available for distribution to unsecured creditors of the Canadian Debtors. We are currently
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Table of Contentsunable to quantify the total potential amounts claimed under the EMEA Claims, as many of the claims were not quantified. The EMEA Claims that were quantified total approximately CAD$9.8 billion. In addition, the U.K. Pension Trust Limited and the Board of the Pension Protection Fund in the U.K. filed an estimated claim of CAD$3.7 billion in respect of an alleged deficit in the U.K. pension plan (the U.K. Pension Claim). Should the EMEA Claims and the U.K. Pension Claim ultimately be allowed in the CCAA Proceedings on the basis filed, they could have the effect of doubling (or more) the otherwise estimated CCAA claims pool and, accordingly, significantly reduce potential distributions to other unsecured creditors of the Canadian Debtors. Further, counsel for 131 former employees of NNSA have submitted a letter indicating they would file proofs of claims in connection with an action that is currently before the courts in France. On September 30, 2009, the EMEA Debtors and certain of their affiliates (collectively, the EMEA Original Claimants) filed over 350 proofs of claim against the U.S. Debtors and unspecified directors and officers of the U.S. Debtors in the U.S. Court. On May 10, 2011, the U.S. Court entered an order requiring the EMEA Original Claimants to file more definite statements of their previously-filed claims, and to file any other pre-petition claims against the U.S. Debtors, by June 1, 2011, absent which any of their pre-petition claims would be disallowed. The deadline for filing amended proofs of claim was later extended on request of certain of the EMEA Original Claimants to June 3, 2011 (U.S. EMEA Claims Bar Date). The EMEA Original Claimants filed 38 amended proofs of claim on June 3, 2011. The remaining proofs of claim that had been filed by the EMEA Original Claimants and were not amended on a timely basis have been disallowed and expunged pursuant to the terms of the U.S. Courts May 10, 2011 order. On July 15 and 22, 2011, the U.S. Debtors and the U.S. Creditors Committee filed joint objections and motions to dismiss the claims of NNUK, NNSA and Nortel Networks (Ireland) Limited and the French Liquidator (collectively, the EMEA Claimants). On August 3, 2011, the U.S. Court issued an order that set October 13 and 14, 2011 as the hearing dates for these motions. The order also requested the Mediator to consider postponing the mediation discussed above until after these hearings and the U.S. Courts decision on the motions to dismiss. On August 9, 2011, the Mediator advised the parties to the mediation that he was postponing the initial procedural meeting to a date to be determined after the U.S. Court releases its decision. The U.S. Court heard the motions on October 14, 2011. On March 20, 2012, the U.S. Court granted the U.S. Debtors and U.S. Creditors Committees motion to dismiss these EMEA Claimants breach of duty of care and other fiduciary duty claims, claims of mismanagement under French law, and the contingent claims arising from the issuance of any financial support direction with respect to the U.K. Pension Plan. The U.S. Court declined to dismiss the remaining claims of these EMEA Claimants at this stage of the proceedings. However, the U.S. Court noted that the arguments raised in the motions were persuasive in showing the weakness and unlikelihood of success of these claims. The decision further noted that the parties dispute will now move to mediation, as noted above. Following the U.S. Courts March 20, 2012 decision, pursuant to a letter dated March 26, 2012 from the Mediator to all parties to the mediation, an introductory mediation session was held on April 24, 2012 whereby mediation parties had the opportunity to meet privately with the Mediator. The Mediator advised that he will continue to hold meetings with individual parties to the mediation in his efforts to work towards a resolution on allocation matters. The Mediator is posting updates of a general nature regarding the mediation, as appropriate, on a website at www.nortelmediation.com. The content of this website is not a part of this report. Developments in the Creditor Protection Proceedings Since the filing of Nortels 2011 Annual Report, the following are the material developments in the sales of its assets and in the Creditor Protection Proceedings. CCAA Proceedings On the Petition Date, the Canadian Debtors obtained an initial order from the Canadian Court for creditor protection for 30 days, pursuant to the provisions of the CCAA, which has since been extended from time to time and most recently to July 31, 2012 and is subject to further extensions by the Canadian Court. Chapter 11 Proceedings On June 21, 2010, the U.S. Debtors filed a motion seeking to terminate certain U.S. retiree and long-term disability (LTD) benefits effective as of August 31, 2010. The U.S Debtors filed a notice of withdrawal of this motion with the U.S. Court on July 16, 2010. In anticipation that the U.S. Debtors will seek modification or termination of some or all of the U.S. retiree and LTD benefits at a later time, on June 21, 2011, upon the motion of the U.S. Debtors dated June 2, 2011, the U.S. Court entered an order directing the U.S. Trustee to establish a committee of retirees for the U.S. Debtors to consult with before undertaking any modification or termination of the U.S. retiree benefits. Additionally, on June 22, 2011, the U.S. Court entered an order directing the U.S Trustee to establish a committee of LTD employees for the U.S. Debtors to consult with before undertaking any modification or termination of the U.S. LTD benefits. On August 2, 2011, the U.S. Trustee appointed the members of these committees. Upon the motion of the U.S. Debtors dated March 28, 2012, on April 18, 2012, the U.S. Court appointed a neutral mediator to mediate discussions between the U.S Debtors, the U.S. Creditors Committee, the Bondholder Group and the retiree and LTD committees regarding a future modification or termination of U.S. retiree and LTD benefits. Internet Protocol Addresses We commenced a process, approved by the Canadian Court, to sell certain residual IT assets primarily consisting of about 17 million Internet Protocol version 4 addresses (IP Addresses), and IT hardware assets including 700 servers. Working together with the Canadian Monitor, our goal is to maximize the value of these residual IT assets in a timely manner. Any definitive sale agreement will require approval of the Canadian Court.
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Table of ContentsOn February 17, 2012, the Canadian Court approved two sale agreements that NNL and Nortel Networks Technology Corporation (NNTC) had entered into for the sale of rights in a small number of our IP Addresses. Under one sale agreement, CSC Holdings LLC, the operating subsidiary of Cablevision Systems Corporation, is the purchaser of a certain number of the IP Addresses, and under the other sale agreement, Salesforce.com Inc. is the purchaser of a certain number of the IP Addresses. The financial and other terms of each of the sale agreements, including the cash purchase price and the IP Addresses included in each sale, have been sealed by order of the Canadian Court because disclosure of such terms may be detrimental to the Canadian Debtors interests in seeking to consummate these and other sales of IP Addresses. Both purchasers have obtained approval from the American Registry for Internet Numbers (ARIN) with respect to the transfer and registration of the IP Addresses in the respective purchasers name upon closing. We closed these sales in the first quarter of 2012 and the proceeds from the transactions have been deposited into an NNL single purpose bank account. The Canadian Debtors and the U.S. Debtors have agreed that any dispute relating to the rights and claims, if any, of the U.S. Debtors in and to the IP Addresses, including to an allocation of such sale proceeds, will be subject to a joint hearing of the Canadian Court and the U.S. Court prior to the distribution of such sale proceeds and, if appropriate, orders of such courts approving such distributions. On April 4, 2012, the Canadian Court approved a further sale agreement that NNL and NNTC had entered into with Bell Aliant Regional Communications, Limited Partnership (Bell Aliant) for the sale of rights in a certain small number of our IP Addresses, which sale closed on April 5, 2012. On May 7, 2012, the Canadian Court approved a further sale agreement we and Vodafone Americas Inc. had entered into for the sale of rights in a small number of our IP Addresses. The proceeds from the sale to Bell Aliant have been deposited into NNLs single purpose bank account, which has been included in non-current restricted cash, and upon the closing of the sale to Vodafone, such proceeds will also be deposited into the same account. Similar to the earlier sales described above, the financial and other terms of these two sale agreements, including the cash purchase price and the IP Addresses included in the sales, were sealed by order of the Canadian Court for the reasons set out above. We continue to seek buyers for the remainder of our IP Addresses. Other Developments Under the CCAA Proceedings, the Canadian Debtors filed a motion for an order authorizing and directing the Canadian Debtors to cease performing any remediation at or in relation to five sites (Belleville, Brampton, Brockville, Kingston and London, Ontario), and that any claims in relation to such remediation be subject to the court approved claims process under the CCAA Proceedings. We brought the motion to disclaim any further obligation for such properties that are no longer owned or used by us and that we and our creditors derive no benefit from any further remediation. Subsequent to the filing of the motion, we entered into a transition agreement regarding the Brampton site that facilitated a gradual cessation of our environmental risk related tasks at that site, which tasks have now been completed. The Ministry of the Environment (the MOE) made remediation orders with respect to the four other sites. The motion was heard in September 2011 in the Canadian Court, wherein the Canadian Debtors sought advice and direction that the MOE remediation orders were in breach of the CCAA stay. The MOE did not seek to enforce the remediation orders while the Canadian Courts decision was outstanding and we continued to undertake environmental risk assessments and remediation related tasks at those sites. On March 9, 2012, the Canadian Court issued an order granting the Canadian Debtors motion, in particular agreeing that the MOE remediation orders are stayed under the CCAA Proceedings and authorizing us to cease performing any remediation activities at or in relation to the five sites, and releasing us from all contractual obligations to carry out remediation requirements at such sites. The order further stipulates that any claims in relation to any current or future remediation requirements by the MOE against us or our current or former directors or officers are subject to resolution and determination in accordance with the claims procedure and claims resolution orders approved by the Canadian Court on July 30, 2009 and September 16, 2010, respectively. On March 23, 2012, Her Majesty the Queen in right of Ontario as represented by the MOE served a notice of motion for leave to appeal the March 9, 2012 Canadian Court order. We have given notice that, pursuant to the order we are ceasing continued remediation activities. Basis of Presentation and Going Concern Considerations For periods ending after the Petition Date, we reflect adjustments to our financial statements in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 852 Reorganization (ASC 852), on the basis that we will continue as a going concern. After consideration of the guidance available in FASB ASC 810 Consolidation (ASC 810) and ASC 852, the accompanying unaudited condensed consolidated financial statements as of March 31, 2012 and December 31, 2011 and for the three months ended March 31, 2012 and 2011 have been presented on the following basis with respect to our subsidiaries:
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We continue to exercise control over our subsidiaries located in Canada, CALA and Asia (other than those entities that are EMEA Subsidiaries or U.S. Subsidiaries), and our financial statements are prepared on a consolidated basis with respect to those subsidiaries. We will continue to evaluate our remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress. See note 1 to the accompanying unaudited condensed consolidated financial statements for further information on our basis of presentation and going concern considerations. Reporting Requirements As a result of the Creditor Protection Proceedings, we are periodically required to file various documents with and provide certain information to the Canadian Court, the U.S. Court, the English Court, the Canadian Monitor, the U.S. Creditors Committee, the U.S. Trustee and the U.K. Administrators. Depending on the jurisdictions, these documents and information may include statements of financial affairs, schedules of assets and liabilities, monthly operating reports, information relating to forecasted cash flows, as well as certain other financial information. Such documents and information, to the extent they are prepared or provided by us, will be prepared and provided according to requirements of relevant legislation, subject to variation as approved by an order of the relevant court. Such documents and information may be prepared or provided on an unconsolidated, unaudited or preliminary basis, or in a format different from that used in the financial statements included in our periodic reports filed with the SEC. Accordingly, the substance and format of these documents and information may not allow meaningful comparison with our regular publicly-disclosed financial statements. Moreover, these documents and information are not prepared for the purpose of providing a basis for an investment decision relating to our securities, or for comparison with other financial information filed with the SEC. For a full discussion of the risks and uncertainties we face as a result of the Creditor Protection Proceedings, including the risks mentioned above, see the Risk Factors section of this report. Further information pertaining to our Creditor Protection Proceedings may be obtained through our website at www.nortel.com. Certain information regarding the CCAA Proceedings, including the reports of the Canadian Monitor, is available at the Canadian Monitors website at www.ey.com/ca/nortel. Documents filed with the U.S. Court and other general information about the Chapter 11 Proceedings are available at http://chapter11.epiqsystems.com/nortel. The content of the foregoing websites is not a part of this report. Our Business We have completed the sales of all of our businesses. We continue to oversee and fulfill the residual contracts not transferred to the various buyers. As a result, commencing with the first quarter of 2011, we have one reportable segment as our chief operating decision maker reviews financial and operating results and makes decisions on that basis. Revenues Revenues in the first quarter of 2012 were $1 as compared to $20 in the first quarter of 2011 representing a decrease of $19 due to the sale of the MSS business. SG&A Expense
Selling, General and Administrative (SG&A) expense decreased to $27 in the first quarter of 2012 from $38 in the first quarter of 2011, a decrease of $11 or 29%. The decrease in SG&A expense was primarily due to headcount reductions and other cost reduction activities, partially offset by variances in provisions for doubtful accounts. Pre-Petition Date Cost Reduction Plans In the first quarter of 2012, charges related to restructuring plans were minimal. As a result of the Creditor Protection Proceedings, we ceased taking any further actions under our 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 under such plans, and will be classified in cost of revenues,
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Table of ContentsSG&A and R&D as applicable. Our contractual obligations are subject to re-evaluation in connection with the Creditor Protection Proceedings and, as a result, expected cash outlays relating to contract settlement and lease costs are subject to change. As well, we are not following our pre-Petition Date practices with respect to the payment of severance in jurisdictions under the Creditor Protection Proceedings. Recoveries primarily result from lease repudiations and other liabilities relinquished due to the Creditor Protection Proceedings and severance related accruals released from pre-Petition Date restructuring plans and re-established under postPetition Date cost reduction activities. For a description of our previously announced restructuring plans and further details of the charges (recoveries) incurred, refer to note 6 to the accompanying unaudited condensed consolidated financial statements. Post-Petition Date Cost Reduction Activities In connection with the Creditor Protection Proceedings, we have taken and expect to take further workforce and other cost reduction actions. 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 to earnings and cash outlays are subject to change as a result of our 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 For the three months ended March 31, 2012, approximately $4 of charges relating to the net workforce reduction of 51 positions were incurred. As of March 31, 2012, our workforce reduction provision balances were approximately $147, which were classified as subject to compromise. As we continue to progress through the Creditor Protection Proceedings, we expect to incur charges and cash outlays related to workforce and other cost reduction strategies. We will continue to report future charges and cash outlays under the broader strategy of the post-Petition Date cost reduction plan. Other Cost Reduction Activities For the three months ended March 31, 2012 and 2011, there were no charges related to Nortels real estate cost reduction activities. As of March 31, 2012, our real estate and other cost reduction balances were approximately $7, which are classified as liabilities subject to compromise. As of December 31, 2011, Nortels real estate and other cost reduction balances were approximately $6, which are classified as subject to compromise. Other Operating Income Net The components of other operating income net were as follows:
In the first quarter of 2012, other operating income net was $1. In the first quarter of 2011, other operating income net was $24 due primarily to billings related to TSAs.
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Table of ContentsOther Expense Net The components of other expense net were as follows:
In the first quarter of 2012, other expense net was $10, primarily comprised of currency exchange loss of $6 and other - net of $4. In the first quarter of 2011, other expense net was a $12, primarily due to a currency exchange loss of $10 and other net of $3. Interest Expense We have continued to accrue for interest expense in the first quarter of 2012 of $87 and in the first quarter of 2011 of $79 in our normal course of operations related to debt issued by NNC or NNL in Canada until we obtain a claims determination order that adjudicates the claims. During the pendency of the Creditor Protection Proceedings, we generally have not made and do not expect to make payments to satisfy the interest obligations of the Debtors. We have continued to accrue interest on the $1,000 floating rate notes that matured on July 15, 2011 until we obtain a claims determination order that adjudicates the claim. Reorganization Items net Reorganization items represent the net direct and incremental charges related to the Creditor Protection Proceedings such as revenues, expenses including professional fees directly related to the Creditor Protection Proceedings, realized gains and losses, and provisions for losses resulting from the reorganization and restructuring of the business. Reorganization items for the three months ended March 31, 2012 and 2011 consisted of the following:
Income Tax Expense During the three months ended March 31, 2012, we recorded a tax expense of $5 on loss from operations before income taxes of $54. The tax expense of $5 is comprised of $4 resulting from taxes on earnings in Asia, $1 of other taxes including withholding taxes, and $1 resulting from a provision for actual tax adjustments to the prior year balances, partially offset by decreases in uncertain tax positions of $1. During the three months ended March 31, 2011, we recorded a tax recovery of $1 on loss from operations before income taxes of $103. The tax recovery of $1 is comprised of a net tax recovery relating to prior years of $2, partially offset by other taxes of $1.
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Table of ContentsWe continue to assess the valuation allowance recorded against our deferred tax assets on a quarterly and annual basis. The valuation allowance is in accordance with FASB ASC 740 Income Taxes (ASC 740), which requires us to establish a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of a companys deferred tax assets will not be realized. Based on the available evidence, we have determined that a full valuation allowance continues to be necessary as of March 31, 2012 for all jurisdictions. For additional information, see Application of Critical Accounting Policies and Estimates Income Taxes in this section of this report. Liquidity and Capital Resources Overview As of March 31, 2012, our cash and cash equivalents balance was $724. Our consolidated cash is held globally in various Nortel consolidated entities and joint ventures as follows, as of March 31, 2012: $186 in Asia, $276 in Canada, $42 in CALA, $165 in joint ventures (including GDNT), $49 in China and $6 in EMEA. These amounts exclude restricted cash of $7,635, comprised of $7,629 accounted for in Canadian entities and $6 in Asia. See Executive Overview Creditor Protection Proceedings Divestiture Proceeds Received for further information regarding restricted cash held in Canadian entities. Cash balances related to the EMEA Subsidiaries and the U.S. Subsidiaries are no longer included in our consolidated cash balance as a result of the previously reported changes to cost accounting. As of March 31, 2012, approximately $7,800 in net proceeds has been generated and received through the completed sales. As of March 31, 2012, $7,320 of the divestiture proceeds received is being held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. An additional $229, reflecting proceeds from the sale of LGN, is included in restricted cash. During the three months ended March 31, 2012, we received additional proceeds of $70 that had been held in escrow subject to the successful completion of performance obligations under the TSAs entered into in connection with the sale of substantially all of our CDMA business, LTE Access assets, and CVAS business, and our North American GSM business, all of which were recorded as gain on divestitures included in reorganization items net. As of March 31, 2012, a further $27 in the aggregate was expected to be received in connection with the sales completed to date, subject to the satisfaction of various conditions. Such amount, when received, will also be held in escrow until the final allocation of these proceeds as between various Nortel legal entities is ultimately determined. See Executive Overview Creditor Protection Proceedings Divestiture Proceeds Received. Historically, we have deployed our cash throughout the corporate group, through a variety of intercompany borrowing and transfer pricing arrangements, which are largely no longer in effect. As a result of the Creditor Protection Proceedings, cash in the various jurisdictions is generally available to fund operations in that particular jurisdiction, but generally is not available to be freely transferred between jurisdictions, regions, or outside joint ventures, other than for normal course intercompany trade and pursuant to specific court-approved agreements as discussed below. Thus, there is pressure and reliance on cash balances and generation capacity in specific regions and jurisdictions. We have established certain cash collateralized facilities in certain jurisdictions. Approximately $7 of cash collateral has been posted by Nortel in support of certain performance bonds and letter of credit facilities. To enable certain Nortel subsidiaries (APAC Agreement Subsidiaries) in the Asia Pacific (APAC) region to continue their respective business operations and to facilitate the business divestitures, the Debtors (other than the Israeli Debtors) entered into an Asia Restructuring Agreement (APAC Agreement). Under the APAC Agreement, the APAC Agreement Subsidiaries have paid a portion of the pre-petition intercompany Debt to the Debtors (other than the Israeli Debtors). As of March 31, 2012, the Canadian Debtors, the U.S. Debtors and the EMEA Debtors have received to date approximately $37, $36 and $28, respectively, in aggregate in respect of the APAC Agreement. Further portions of the pre-petition intercompany debt continue to be repayable from time to time only to the extent of any such APAC Agreement Subsidiarys net cash balance at the relevant time, and subject to certain reserves and provisions. We continue several initiatives to generate cost reductions and decrease the rate of cash outflow during the Creditor Protection Proceedings. Some of these initiatives include the workforce reduction plan announced on February 25, 2009 and other ongoing workforce and cost reduction activities and reviews of our real estate and other property leases, IT equipment agreements, supplier and customer contracts and general discretionary spending as well as our new organizational structure announced on August 10, 2009. With the completed sales of all of our businesses, we are focused on maximizing proceeds with respect to remaining assets. This includes the winding up of our remaining operations and subsidiaries globally, which can involve orderly wind-ups as well as commencement of liquidation proceedings, as the circumstances warrant. Our current cash management system and consolidated cash on hand to fund our operations is subject to ongoing review and approval by the Canadian Monitor and may be impacted by the Creditor Protection Proceedings. The U.S. Principal Officer and the U.K. Administrators oversee the cash management system in their respective jurisdictions and those amounts are not included in our consolidated balance sheet as of March 31, 2012. There is no assurance that (i) we will be able to maintain our current cash management system; (ii) we will generate sufficient cash to fund and wind down our operations; (iii) cash collateralized facilities in
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Table of Contentscertain jurisdictions will be sufficient for our business needs or that we will not have to provide further cash collateral; or (iv) the Debtors will be able to access proceeds in a timely manner from the divestitures as allocation of proceeds from the divestitures of our businesses and assets remains unresolved. Cash Flows Our total consolidated cash and cash equivalents excluding restricted cash decreased by $27 during the three months ended March 31, 2012 to $724, primarily due to cash flows attributable to the net cash used in operations. Our liquidity and capital resources are primarily impacted by: (i) current cash and cash equivalents, (ii) operating activities, (iii) investing activities, and (iv) foreign exchange rate changes. The following table summarizes our cash flows by activity and cash on hand as of March 31, 2012 and 2011:
Operating Activities In the first three months of 2012, our net cash used in operating activities of $51 resulted from use of cash of $99 from non-cash items and net loss attributable to NNC of $63, partially offset by changes in operating assets and liabilities of $111. Net cash from changes in operating assets and liabilities was mainly due to the decrease in accounts receivable of $14, change in payroll, contractual and accrued liabilities of $108 and increase in income taxes payable of $5, partially offset by the decrease in accounts payable of $15. The primary non-cash items were $87 in reorganization items under ASC 852 and other of $30, partially offset by pension and other accruals of $11, amortization and depreciation of $2, and earnings attributable to non-controlling interests of $4. In the first three months of 2011, our net cash used in operating activities of $50 resulted from net loss attributable to NNC of $105 and non-cash items of $26, partially offset by cash from changes in operating assets and liabilities of $81. The net cash from changes in operating assets and liabilities was mainly due to the reduction of accounts receivable of $27, changes in inventories and deferred cost of $4 and $3, respectively, the change in payroll, accrued and contractual liabilities of $51, and the change in other operating assets and liabilities of $25, partially offset by the change in deferred revenues of $8, the decrease in accounts payable of $18, and the change in advanced billings of $3. The primary additions to our net loss for non-cash items were pension and other accruals of $14, amortization and depreciation of $10, more than offset by reorganization items under ASC 852 of $32 and other net of $21. Investing Activities In the first three months of 2012, net cash from investing activities was $14 primarily due to proceeds related to sale of businesses and assets of $77, which were reclassified to restricted cash and cash equivalents resulting in an increase in restricted cash and cash equivalents. The increase in restricted cash and cash equivalents related to proceeds was partially offset by decreases in restricted cash and cash equivalents of $14 primarily related to distributions from the Canadian Health and Welfare Trust. In the first three months of 2011, net cash from investing activities was $9 primarily due to proceeds related to sale of businesses and assets of $49, partially offset by an increase in restricted cash and cash equivalents of $40. Financing Activities In the first three months of 2012 and 2011, cash used in financing activities was nil.
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Table of ContentsOther Items In the first three months of 2012, our cash position was positively impacted by $10 due to the favorable effects of changes in foreign exchange rates primarily from movements of the Canadian Dollar and Indian Rupee against the U.S. Dollar. In the first three months of 2011, our cash position was positively impacted by $9 due to the favorable effects of changes in foreign exchange rates. Fair Value Measurements We utilize observable (Level 1 and Level 2) inputs in determining the fair value of our long-term debt outstanding, as applicable. Future Uses of Liquidity The matters described below, to the extent that they relate to future events or expectations, may be significantly affected by our Creditor Protection Proceedings. Those proceedings will involve, or may result in, various restrictions on our activities and/or the need to obtain third party approvals for various matters. Our cash requirements, excluding distributions from restricted cash which may occur from time to time, for the 12 months commencing April 1, 2012 are primarily expected to consist of funding for operations and the following items:
Off-Balance Sheet Arrangements Bid, Performance-Related and Other Bonds During the normal course of business, we have provided bid, performance, warranty and other types of bonds, which we refer to collectively as bonds, via financial intermediaries to various customers in support of commercial contracts, typically for the supply of telecommunications equipment and services. If we fail to perform under the applicable contract, the customer may be able to draw upon all or a portion of the bond as a remedy for our failure to perform. The contracts that these bonds support generally have terms up to one year. Bid bonds generally have a term of less than twelve months, depending on the length of the bid period for the applicable contract. Performance-related and other bonds generally have a term consistent with the term of the underlying contract. Historically, we have not made material payments under these types of bonds and as a result of the Creditor Protection Proceedings we do not anticipate that we will be required to make any such payments during the pendency of the Creditor Protection Proceedings. The following table provides information related to these types of bonds as of:
Application of Critical Accounting Policies and Estimates Our accompanying unaudited condensed consolidated financial statements are based on the selection and application of U.S. GAAP, which require us to make significant estimates and assumptions. We believe that the accounting policies and estimates as disclosed in our 2011 Annual Report, as well as the following accounting policies and estimates, may involve a higher degree of judgment and complexity in their application and represent our critical accounting policies and estimates. We have discussed the application of these critical accounting policies and estimates with the audit committee of our board of directors.
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Table of ContentsCreditor Protection Proceedings Of the $7,800 in proceeds received from divestitures of businesses and remaining patents and patent applications as of March 31, 2012, $7,320 is being held in escrow and an additional $229, reflecting proceeds from the sale of LGN, is included in restricted cash, all of which is currently reported in NNL solely for financial reporting purposes. The ultimate determination of the final allocation of such proceeds among the various Nortel legal entities, including entities that are not consolidated in these financial statements, has not yet occurred and may be materially different from the NNL classification and related amounts shown in these financial statements. Adjustments to the NNL classification and any related amounts arising from the ultimate allocation will be recognized when finalized. The NNL classification and related amounts shown in these financial statements are not determinative of, and have not been accepted by any debtor estate, any party in interest in the Creditor Protection Proceedings or any court overseeing such proceedings, for purposes of deciding the final allocation of divestiture proceeds. ASC 852 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. In addition, a number of proofs of claim, for which Nortel has not accrued any amount or accrued significantly less than the amounts in the proofs of claim, continue to be reviewed by the Canadian Debtors and may result in significant changes in future periods once these reviews are complete. A number of these proofs of claim, which total approximately $287, relate to certain real estate guarantees provided by NNL in respect of leases entered into by certain EMEA Subsidiaries and U.S. Subsidiaries. As of May 4, 2012, we had 498,206,366 NNC common shares outstanding. Cautionary Notice Regarding Forward-Looking Information Certain statements in this report may contain words such as could, expect, may, should, will, anticipate, believe, intend, estimate, target, plan, envision, seek and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we conduct our remaining business. These statements are subject to important assumptions, risks and uncertainties that are difficult to predict, and the actual outcome may be materially different. Our assumptions, although considered reasonable by us at the date of this report, may prove to be inaccurate and consequently our actual results could differ materially from the expectations set out herein. Actual results or events could differ materially from those contemplated in forward-looking statements as a result of the following: (i) risks and uncertainties relating to the Creditor Protection Proceedings including: (a) risks associated with our ability to: obtain required approvals and successfully consummate remaining divestitures; ability to satisfy remaining transition services agreement obligations in connection with the divestiture of business and assets; successfully conclude ongoing discussions for the sale of our remaining assets; develop, obtain required approvals for, and implement a court-approved plan; allocation of the sale proceeds
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Table of Contentsof our businesses and assets among the various Nortel entities participating in these sales may take considerable time to resolve; resolve ongoing issues with creditors and other third parties whose interests may differ from ours; maintain adequate cash on hand in each of our jurisdictions to fund our remaining work within the jurisdiction during the Creditor Protection Proceedings; obtain any further required approvals from the Canadian Monitor, the U.K. Administrators, the U.S. Principal Officer, the U.S. Creditors Committee, or other third parties; utilize net operating loss carryforwards and certain other tax attributes in the future; avoid the substantive consolidation of NNIs assets and liabilities with those of one or more other U.S. Debtors; operate effectively, and in consultation with the Canadian Monitor, the Canadian creditors committee, the U.S. Creditors Committee, the U.S. Principal Officer, work effectively with the U.K. Administrators, and French Liquidator in their respective administration of the EMEA businesses subject to the Creditor Protection Proceedings; continue as a going concern; actively and adequately communicate on and respond to events, media and rumors associated with the Creditor Protection Proceedings; retain and incentivize key employees; retain, or if necessary, replace suppliers on acceptable terms and avoid disruptions in our supply chain regarding our remaining stranded contracts and operations; obtain court orders or approvals with respect to motions filed from time to time; resolve claims made against us in connection with the Creditor Protection Proceedings for amounts not exceeding our recorded liabilities subject to compromise; prevent third parties from obtaining court orders or approvals that are contrary to our interests; and (b) risks and uncertainties associated with: limitations on actions against any Debtor during the Creditor Protection Proceedings; the values, if any, that will be ascribed pursuant to any court-approved plan to outstanding Nortel securities and, in particular, that we do not expect that any value will be prescribed to the NNC common shares or the NNL preferred shares in any such plan; the delisting of NNC common shares from the NYSE; and the delisting of NNC common shares and NNL preferred shares from the TSX; and (ii) risks and uncertainties relating to our remaining restructuring work including: fluctuations in foreign currency exchange rates; the sufficiency of workforce and cost reduction initiatives; any adverse legal judgments, fines, penalties or settlements related to any significant pending or future litigation actions; failure to maintain integrity of our information systems; and our potential inability to maintain an effective risk management strategy. For additional information with respect to certain of these and other factors, see the Risk Factors section of this report. Unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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Capitalized terms used in this Item 4 of Part I and not otherwise defined, have the meaning set forth for such terms in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of this report. Management Conclusions Concerning Disclosure Controls and Procedures We carried out an evaluation under the supervision and with the participation of management, including the Chief Financial Officer (CFO) Allan Bifield, pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (Exchange Act), of the effectiveness of our disclosure controls and procedures as at March 31, 2012. Based on this evaluation, management, including the CFO, have concluded that our disclosure controls and procedures as at March 31, 2012 were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required and that it is accumulated and communicated to our management, including the CFO, as appropriate, to allow timely decisions regarding required disclosure. Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act. Our internal control over financial reporting is intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that:
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Changes in Internal Control Over Financial Reporting On January 14, 2009, we commenced the Creditor Protection Proceedings and adopted ASC 852. In connection with these events, during the first quarter of 2009, we introduced processes to: (1) determine the Debtors pre- and post-petition liabilities and identify those liabilities subject to compromise; (2) assess certain claims received from creditors; and (3) determine the proper accounting treatment required for contracts, liabilities and operating expenses, including restructuring activities and reorganization expenses during the pendency of the Creditor Protection Proceedings. Complexities exist in introducing such processes given the multiple-jurisdiction element of our Creditor Protection Proceedings. From 2009 through 2011, we completed the sale of all of our business as well as the sale of our remaining patents and patent applications and streamlined our business infrastructure and implemented processes to separate and track financial performance in connection with our transition services obligations associated with these divestitures. These changes materially affected our internal control over financial reporting throughout 2009, 2010 and 2011 and are reasonably likely to continue to materially affect our internal control over financial reporting. In the fourth quarter of 2011, we continued to streamline our business infrastructure mainly in response to the substantial completion of the TSA obligations. In the first quarter of 2012, we implemented a new financial reporting system tailored to meet the simplified needs of our current restructuring activities and modified our processes, where needed, to ensure appropriate internal controls over our financial reporting continue to exist. Management continues to take actions necessary to address the resources, processes and controls related to these changes, and to take any remaining actions pertaining to the realignment of certain work between the Canadian Debtors and U.S. Debtors as part of the separation of various corporate functions, while maintaining effective control over financial reporting. Additional process changes may be necessary in the future.
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Table of ContentsPART II OTHER INFORMATION Capitalized terms used in this Part II and not otherwise defined, have the meaning set forth for such terms in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of this report.
Other than as described below, there have been no material developments in our material legal proceedings as previously reported in our 2011 Annual Report. For additional discussion of other material legal proceedings, see Contingencies in note 16 of the accompanying unaudited condensed consolidated financial statements. Environmental Matters Under the CCAA Proceedings, the Canadian Debtors filed a motion for an order authorizing and directing the Canadian Debtors to cease performing any remediation at or in relation to five sites (Belleville, Brampton, Brockville, Kingston and London, Ontario), and that any claims in relation to such remediation be subject to the court approved claims process under the CCAA Proceedings. We brought the motion to disclaim any further obligation for such properties that are no longer owned or used by us and that we and our creditors derive no benefit from any further remediation. Subsequent to the filing of the motion, we entered into a transition agreement regarding the Brampton site that facilitated a gradual cessation of our environmental risk related tasks at that site, which tasks have now been completed. The Ministry of the Environment (the MOE) made remediation orders with respect to the four other sites. The motion was heard in September 2011 in the Canadian Court, wherein the Canadian Debtors sought advice and direction that the MOE remediation orders were in breach of the CCAA stay. The MOE did not seek to enforce the remediation orders while the Canadian Courts decision was outstanding and we continued to undertake environmental risk assessments and remediation related tasks at those sites. On March 9, 2012, the Canadian Court issued an order granting the Canadian Debtors motion, in particular agreeing that the MOE remediation orders are stayed under the CCAA Proceedings and authorizing us to cease performing any remediation activities at or in relation to the five sites, and releasing us from all contractual obligations to carry out remediation requirements at such sites. The order further stipulates that any claims in relation to any current or future remediation requirements by the MOE against us or our current or former directors or officers are subject to resolution and determination in accordance with the claims procedure and claims resolution orders approved by the Canadian Court on July 30, 2009 and September 16, 2010, respectively. On March 23, 2012, Her Majesty the Queen, in right of Ontario as represented by the MOE, served a notice of motion for leave to appeal the March 9, 2012 Canadian Court order. We have given notice that, pursuant to the order, we are ceasing continued remediation activities.
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Certain statements in this report may contain words such as could, expect, may, should, will, anticipate, believe, intend, estimate, target, plan, envision, seek and other similar language and are considered forward-looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections. In addition, other written or oral statements that are considered forward-looking may be made by us or others on our behalf. These statements are subject to important assumptions, risks and uncertainties that are difficult to predict and actual outcomes may be materially different. The Creditor Protection Proceedings are having a direct impact on our business and are exacerbating these risks and uncertainties. In particular, the risks described herein and in our 2011 Annual Report could cause actual events to differ materially from those contemplated in forward-looking statements. Unless otherwise required by applicable securities laws, we do not have any intention or obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition to the other information set forth in this report, you should carefully consider the factors discussed in the Risk Factors section in our 2011 Annual Report which could materially affect our business, results of operations, financial condition or liquidity. The risks described in our 2011 Annual Report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may materially adversely affect our business, results of operations, financial condition and liquidity. The risks described in our 2011 Annual Report have not materially changed.
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Global Class Action Settlement: We entered into agreements to settle two significant U.S. and all but one Canadian class action lawsuits, collectively the Global Class Action Settlement, which became effective on March 20, 2007 following approval of the agreements by the appropriate courts. In accordance with the terms of the Global Class Action Settlement, a total of 62,866,775 NNC common shares were to be issued. During the three-month period ended March 31, 2012, no NNC common shares were issued in accordance with the settlement. Almost all of the NNC common shares issuable in accordance with the settlement have been distributed to claimants and plaintiffs counsel, most of them in the second quarter of 2008. The issuance of the 62,866,775 NNC common shares is exempt from registration pursuant to Section 3(a)(10) of the Securities Act.
Pursuant to the rules and regulations of the SEC, we have filed certain agreements as exhibits to this Quarterly Report on Form 10-Q. These agreements may contain representations and warranties by the parties. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in our public disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe our actual state of affairs at the date hereof and should not be relied upon.
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Table of ContentsSIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NORTEL NETWORKS CORPORATION (Registrant)
Date: May 10, 2012
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